Category: Banking Culture

Banks can target service before sales to avoid a banking royal commission

From The Conversation.

The US$185 million fine levied on US bank Wells Fargo for unauthorised accounts opened by employees seeking bonuses appears to have become a tipping point for industry action in Australia.

Reacting to sales targets and bonus incentives, Wells Fargo employees artificially inflated their sales by secretly opening accounts. They then transferred funds using these accounts, triggering overdraft fees and other charges. Staff also falsely opened credit card and debit card accounts, causing credit card holders to incur annual fees. Debit cards were issued with PINs, again without the customer’s knowledge. More than two million such fake accounts were created.

commission

This week Westpac chief Brian Hartzer said the bank would remove all product-related incentives across its 2,000 branch tellers and instead base their incentives on customer feedback about service quality.

The move comes after a long history of sales-driven banking cultures. Wells Fargo confirmed it had fired over 5,300 employees for such behaviour, between January 2011 and March 2016.

Employees of Wells Fargo had been vocal about the high-pressure culture that existed in the bank in an LA Times article in 2013. They spoke of being regularly humiliated by managers in front of their colleagues and threatened with the sack for failing to meet targets. Some begged family members to sign up and open unneeded accounts. The root cause of this pressure on Wells Fargo employees was the bank’s corporate culture, and a cross-selling target of at least eight financial products per customer.

US regulators say the record fine levied on Wells Fargo should “Serve notice to the entire industry that such initiatives need to be carefully monitored as a basic element in any company’s compliance program, to make sure that incentives for employees are aligned with the welfare of customers”.

Such misdemeanour’s by financial services providers are not unusual. Earlier in 2016 Santander Bank was fined US$10 million for allegedly enrolling customers in overdraft protection services that they had never authorised.

Regulators in Australia have also become concerned that sales incentives are harming the financial industry’s integrity. The Australian Bankers Association is conducting a review of “product sales commissions and product based payments that could lead to poor customer outcomes”.

In its submission to the review, the Finance Sector Union of Australia (FSU) has focused on these poor customer outcomes. It puts much of the blame on the “conflicted remuneration” that causes “the systematic application of remuneration and work systems that drive employees to sell and/or push products and services” to bank customers.

The FSU submission is based on a survey of 1,298 bank employees undertaken in August 2016. Based on feedback from members, it says bank staff employment is often dependent on “their ability to gain referrals, sell the product of the week or reach a volume based target”. The FSU concludes that “existing remuneration systems are having a detrimental effect on the lives of bank employees” and that the Australian banking industry’s remuneration systems is “causing the industry harm”.

This week Reserve Bank Governor Philip Lowe also weighed in, saying remuneration structures within financial institutions should promote behaviour that benefits not just an institution, but its client.

Australian banks are some of the most profitable in the world and are in a strong position to lead by example in gaining and then sustaining the trust of their customers. Cross selling of products and services can be achieved by a rigorous focus on customer service that produces not just customer satisfaction, but customer delight.

Achieving this means confronting the dilemmas created by “conflicted remuneration,” whereby bank executive rewards are directly related to sales and subsequent profitability. If sales targets continue to lead to customer harm, banks will lose the vital ingredient of trust that banking relies on. And those calling for a banking royal commission will be granted their wish.

Author: Steve Worthington, Adjunct Professor, Swinburne University of Technolog

The End of the Commission Remuneration Model In Financial Services?

The wind of change seems to be blowing though the financial services sector as the focus on doing the right thing for customers increases. The industry’s dirty secret is that many in the sector are rewarded on a commission basis for selling products and services, irrespective of whether they are right for the customer concerned. Recent scandals have been all about the interests of the industry coming ahead of consumers, whether employed by the firm, or an “independent” advisor.

commissionThis entrenched practice took root as players sought to boost profit by cross selling and up-selling more products to their customers, and targets, plus commissions became a pretty standard, if undisclosed, practice when working with third party advisors.

Whether a bank teller, a financial advisor, a mortgage broker, or other bank employee; behaviour is likely to be influenced by expectations of personal remuneration. This is not transparent to the consumer, who relies on the advice.

But this week we may be seeing signs of a new set of practices emerging. Westpac has said it will no longer pay sales commissions to bank tellers, but performance will be assessed by customer satisfaction. Changes are also afoot in the sales force too.

From next month we’re planning to remove all product related incentives across our 2,000 tellers in the Westpac branch network. Rather, their incentives will be based entirely on customer feedback about the quality of service they received in the branch.

We have also revisited the way we reward specialised sales roles in our network. We will no longer vary reward values based on different products; but rather our people will be rewarded for meeting the full range of our customers’ needs.

The Hansard record of the new RBA Governor’s comments this week made some interesting points about remuneration in financial services and the cultural issues arising.

Mr THISTLETHWAITE: You mentioned earlier your mandate in terms of financial systems stability. There has been a whole host of scandals in recent years with the banks, particularly with their wealth management arms. It is an issue that this committee is going to inquiry into in the coming months. This is a bit of a left-field question, but, from a regulatory perspective, if you were redesigning our financial system regulation in Australia what would you change?
Dr Lowe: I do not think a whole redesign is required.
Mr THISTLETHWAITE: Would you change anything?
Dr Lowe: APRA is the financial regulator, so it is not the Reserve Bank. And APRA has made many changes to the nature of financial regulation recently—really around capital and liquidity. So I think the finance sector feels like it has gone through a period of very accelerated regulatory change. It is best, probably, to kind of let that settle and see how the system adjusts to it. I sense that you are asking about other types of regulation that really go to the issue of bank culture.
Mr THISTLETHWAITE: Is there anything you want to say about that?
Dr Lowe: I cannot help but agree with you that there have been too many examples of poor outcomes, particularly in the wealth management and insurance industries. That is disappointing to us all.
Maybe I can make two other remarks—and, again, a broader perspective. The Australian bank system has performed well over a couple of decades. We did not have the excessive risk-taking culture in the lead-up to the financial crisis. I think that is really important. If we had a really bad risk-taking culture, we could have ended up in the same situation as many other countries did. Part of it is due to APRA’s good regulation, but the banks did not develop this culture that we saw overseas. So that has given us more stability. Again, that is a first-order point.

In terms of behavioural issues—it is hard. I think it comes down to incentives within the organisations, and that is largely remuneration structures. That is a responsibility of management. And, probably, APRA can play some constructive role in encouraging remuneration structures that create the right incentives within organisations. If there was one thing that I could focus on—it is not my responsibility; it is not the Reserve Bank’s responsibility—is making sure that the remuneration structures within financial institutions promote behaviour that benefits not just the institution but its client.
What I would like to see is, really, banking return to be seen as a strong service profession. I do not know how far away from that we are. Banking, historically, has been a profession—a profession of stewardship, custodians, service, advisory, counsellor. Is not a marketing or product-distribution business; banking is a profession.

I like the Banking and Finance Oath. I do not know whether you have seen this, but a number of people have signed up to this, including me, and I encourage others to do it as well. Its first line is: ‘Trust is the foundation of my profession.’ We have got to move beyond people just signing this oath to actually making that in practice. I do not run a commercial bank. I do not know how to embed within a commercial bank the idea that trust is the foundation of the noble profession that we do. It is largely about incentives and remuneration.

The Australian Bankers Association had previously announced a Independent Review of Product Sales Commissions and Product Based Payments

The final report is expected to provide an overview of product sales commissions and product based payments in retail banking and other industries, identify possible options for better aligning remuneration and incentives so that they do not result in poor customer outcomes and set out actions which may be considered by banks and the banking industry to implement the findings.

This puts the current ASIC remuneration review of mortgage brokers in a new light perhaps. The outcomes are expected in December. However, this review is being done in secret. As we said in an earlier post:

ASIC has evidently released the final scope of its review of remuneration in the mortgage broking industry – but only to industry insiders. According to media, the corporate regulator has confirmed it will review the remuneration arrangements of “all industry participants forming part of the value distribution chain”. This includes lending institutions, aggregation and broking entities, and associated mortgage businesses – such as comparison websites and market based lending websites – and referral and introducer businesses.

But why, we ask, was the scope not publicly disclosed? Why are ASIC seeking input only from industry participants? We agree the remuneration review is required – but the lack of transparency is a disgrace.

Our guess is that commissions will not be banned, and the findings will focus more on better disclosure.

It is worth remembering that before that the changes to FOFA were disallowed in the Senate in late 2014. The changes would have made if easier for employees to receive incentive payments for product sales.

So now the climate appears to be changing. Will other banks follow Westpac’s lead? Will the remuneration review lead to changes to commission structures (especially trails) or a ban? Could we be seeing signs of fundamental cultural change in the industry? And will consumers be better off?

Worth reflecting on the changes which have emerged in the UK.

From April 2016 investment middlemen, including financial advisers and do-it-yourself investment brokers, will no longer be able to accept commission payments from fund companies.

The changes coming into force are the final phase of a series of new rules that started to apply at the start of 2013, which stopped advisers receiving ongoing, or “trail”, commission on new investments.

This rule has applied to brokers since April 2014. Since this date brokers have not been able to receive ongoing trail commission on new businesses, due to the legislative changes.

But until April 2016 commissions could still be deducted from earlier investments. And it is that backlog of investment which, for many, will soon become cheaper.

From April, instead of taking commissions, all middlemen will have to charge an explicit fee, expressed either as an hourly rate or as a percentage of savers’ investment pot.

The new rules were ushered in to remove any potential bias. But – and this is the catch – these old-style payments will not cease for some investors, such as those who went direct to the fund provider, or invested through a bank.

Westpac to Remove all Teller Product Related Incentives

Westpac Group CEO, Brian Hartzer, at a speech to the Australia Israel Chamber of Commerce in Melbourne called for ongoing and significant changes to the way banks work with their customers.

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The trust gap.

Having said all that, it is impossible to convince someone of the value you’re adding if they don’t trust you. And we need to recognise, that, as an industry, we have a trust gap.

Trust is at the heart of banking. And trust in banking is like trust in any other relationship: It requires that we treat people fairly and honestly.

As a result of things some bankers have done, or the way banks have responded when things have gone wrong, some people have concluded that banks—and bankers—are only out for themselves.

And banks only have themselves to blame for that.

We need to recognise that at times we have not met the expectations of the community. People are saying things need to change. They do need to change.

The good news is they are changing.

Across the industry we are changing processes and we are changing behaviours.

At Westpac we are going back to basics and reviewing all of our products, policies, and processes, to make sure they are working in our customers’ interests.

I’ll give you one small example.

Last week some of you may have read about a mistake we made with one of our products. We weren’t applying a discount properly on some accounts for younger customers. The fees needed to be manually reversed and in some cases they weren’t. Through our reviews we identified the mistake, reported it to ASIC, refunded the money, and have now put automated systems in place to make sure it won’t happen again. Procedural mistakes like this are not acceptable. And they do nothing to help banks regain trust from people who are already skeptical.

Yes, we found it and fixed it: Part of the Westpac ethos is that if we get it wrong we put things back on track.

But this small example shows the need for constant vigilance and continuous improvement on the part of the banking industry.

We’re also focusing on our culture more broadly, reinforcing our goal of being one of the world’s great service companies.

Let me be clear: I am proud of the 40,000 people who work at the Westpac Group. I know that overwhelmingly they come to work each day wanting to deliver great service and help their customers.

Across the company, complaints have fallen by over 70 per cent in the last four years. Over the past three months we had three times as many compliments as complaints in our branch network. This gives me confidence we are on the right track—but we know we need to do more.

We are putting our financial advisers through ethics training, and are incorporating the principles of the banking oath into our code of conduct for all employees.

We are also changing practices that might be seen as creating potential conflicts of interest.

Through the Australian Bankers’ Association we are working to agree on steps the industry can take to eliminate the perception of conflicts of interest in the way front line staff are paid. An independent expert is reviewing those practices and we will adopt whatever is agreed.

Having said that there are things Westpac can do on our own, and we’re moving ahead.

From next month we’re planning to remove all product related incentives across our 2,000 tellers in the Westpac branch network. Rather, their incentives will be based entirely on customer feedback about the quality of service they received in the branch.
We have also revisited the way we reward specialised sales roles in our network. We will no longer vary reward values based on different products; but rather our people will be rewarded for meeting the full range of our customers’ needs.

This is all part of making sure that when our customers walk into a branch, they don’t have cause to question the quality of service that they’re getting, or the motivation of our people.

At the same time we’re reinforcing standards of behaviour, and enforcing consequences when people fall short.

We’re appointing an independent customer advocate who is empowered to resolve issues for our customers. And who can overturn decisions made by our internal dispute resolution process.

And we’re investing more in our compliance and oversight capabilities, to make sure we can quickly spot and resolve issues when they occur.

We’re also continuing to give back to the community, through our support of the Westpac Rescue helicopters, the Westpac Bicentennial Foundation, which gives a hundred scholarships a year, volunteering leave and matching gifts for staff, and 200 Westpac community grants of $10,000 each this year alone.

It’s part of why the Dow Jones Sustainability Index has just recognised Westpac as the world’s most sustainable bank, for the third year in a row.

And we’ll continue to take action now, Royal Commission or not.

Banking Industry Announces Improved Hiring Of Financial Advisers

The Australian Bankers Association says to help banks employ only competent and ethical financial advisers, the banking industry has today announced a new, improved way of hiring financial advisers.

This relates to wealth advisors only, not mortgage brokers. Why not extend it to all types of advice? You could also argue they should be doing this anyway, as part of best practice recruitment.

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“Sometimes a financial adviser can be removed from one financial institution for poor conduct, only to turn up working and continuing their poor practices at another,” Australian Bankers’ Association Executive Director – Retail Policy Diane Tate said.

“To help avoid this, the banking industry has developed a protocol to make it easier to check how financial advisers have performed in previous jobs.

“This will better identify financial advisers who have not met the industry’s minimum legal and ethical standards, and help employers make more informed recruitment decisions,” she said.

The protocol sets minimum standards for checking references and sharing information, through a series of standardised questions and record keeping practices.

“This is an important step by the banking industry to improve the quality of advice, support the professionalisation of the financial advice industry and build trust and confidence in banks,” Ms Tate said.

“The subscribing licensees to the protocol represent 38% of the entire financial advice market. The more widespread this is, the more effective it will be in making sure individuals with poor conduct records don’t move around the industry,” she said.

Banks and other financial advice providers can become a subscribing licensee by contacting the ABA.

Ms Tate said banks and regulators agreed on the need for financial institutions to do more to improve recruitment of financial advisers.

The protocol was developed with input from regulators and other stakeholders. Subscribing licensees will need to make changes to their recruitment practices to comply with the protocol by 1 March 2017.

“The ABA is also progressing work on establishing an industry register of conduct breaches covering all bank employees, which was announced in April as part of new initiatives to address concerns with conduct and culture in banks,” Ms Tate said.

The following table sets out the subscribing licensees to the Protocol.

Name  Subscribing licensee
AMP AMP Financial Planning (AFSL 232706)
Charter Financial Planning (AFSL 234665)
Hillross Financial Services (AFSL 232705)
ipac (AFSL 234656)
SMSF Advice (AFSL 234664)
Australia and New Zealand Banking Group ANZ Financial Planning (AFSL 234527)
Elders Financial Planning (AFSL 224645)
Financial Services Partners (AFSL 237590)
Millennium3 Financial Services (AFSL 244252)
Ri Advice Group (AFSL 238429)
Bendigo and Adelaide Bank Bendigo Financial Planning (AFSL 237898)
Commonwealth Bank BW Financial Advice (AFSL 230727)
Commonwealth Financial Planning (AFSL 231139)
Commonwealth Private (AFSL 314018)
Commonwealth Securities (AFSL 238814)
Count Financial (AFSL 227232)
Financial Wisdom (AFSL 231138)
Macquarie Group Macquarie Equities (AFSL 237504)
National Australia Bank Apogee Financial Planning (AFSL230689)
Garvan Financial Planning (AFSL230692)
Godfrey Pembroke (AFSL 230690)
JBWere (AFSL 341162)
Meritum Financial Group (AFSL245569)
MLC Financial Planning (AFSL230692)
NAB Financial Planning (AFSL 230686)
NAB Financial Planning Self Employed (AFSL 230686)
Suncorp Group Suncorp Financial Services (AFSL 229885)
Westpac Magnitude Group (AFSL 221557)
Securitor Financial Group (AFSL 240687)
Westpac Banking Corporation (AFSL 233714)

Should Wells Fargo execs responsible for bilking customers be forced to return their pay?

From The Conversation.

Having spent five years supervising large financial institutions on Wall Street, I am rarely surprised by the latest news of banks behaving badly.

But even the most hardened cynics, such as myself, were taken aback by the recent announcement that Wells Fargo was being fined US$185 million for fraudulent sales practices that included opening over two million fake deposit and credit card accounts without informing its customers.

Adding to my shock was the revelation that the firm fired 5,300 employees over the course of five years for engaging in this behavior, clearly evidence that this was more than just a few bad apples.

Complaint-TTy

The financial crisis and its aftermath have taught us that it is unlikely any of Wells Fargo’s senior executives will face criminal charges. The reasons for this are numerous, but essentially prosecutors have a hard time identifying criminal intent within the upper ranks of bank management.

At the very least, don’t Wells Fargo’s customers have a reasonable expectation that executives who profited off their misfortune be required to return some of their ill-gotten gains?

The good news is that in April, U.S. regulators released a proposed rule requiring financial institutions to do just that. Unfortunately for fraud victims seeking a pound of flesh from Wells Fargo executives, the rule is not scheduled to be finalized until November, although the bank claims to be in adherence with the proposal’s main provisions.

Nonetheless, I thought it would be interesting to examine the text of the proposed incentive-based compensation rule through the lens of the Wells Fargo situation to try and understand its potential implications.

Cultural failure

On the surface Wells Fargo’s fraud appears to be an all-too-familiar case of cultural failure within a big financial institution. Apparently CEO John Stumpf disagrees.

In a Wall Street Journal interview shortly after the story broke, Stumpf refused to admit any institutional failure at the bank, claiming the behavior of the terminated employees “in no way reflects our culture nor reflects the great work the other vast majority of the people do.”

If Stumpf thinks that over 5,000 unethical people just so happened to find their way to Wells Fargo, he may want to rethink the company’s hiring practices.

Thus far the company has declined to say how many branch, regional or corporate managers were among those let go. The initial readout seems to be that most of those dismissed were low-level branch employees – hardly your typical Wall Street villains.

The spotlight has now turned to senior managers, and what they did or did not know. It is shining brightest on Carrie Tolstedt, who has run Wells Fargo’s community banking division since 2008 and is set to retire at the end of the year. Tolstedt appears to have profited handsomely from the sales practices in question.

A 2015 company filing indicates that part of Tolstedt’s 2014 inventive compensation award of roughly $8 million stems from:

“success in furthering the company’s objectives of cross-selling products from other business lines to customers, reinforcing a strong risk culture and continuing to strengthen risk management practices in our businesses.”

It now appears that cross-selling products and strengthening risk management were competing objectives.

Clawing back compensation

As noted earlier, Wells Fargo says it’s already in compliance with the main provisions of the proposed rule.

Specifically, in a recent filing, the bank claims:

“Wells Fargo has strong recoupment and clawback policies in place designed so that incentive compensation awards to our named executives encourage the creation of long-term, sustainable performance, while at the same time discourage our executives from taking imprudent or excessive risks that would adversely impact the Company.”

This means the bank can cancel, or claw back, any incentive-based executive compensation, such as deferred bonuses or stock options, from executives who engaged in misconduct or who received such compensation based upon materially inaccurate information, “whether or not the executive was responsible.”

Thus far the company has given no indication it intends to claw back any of Tolstedt’s compensation, although pressure from the public and regulators may soon change this.

The proposed rule

So let’s imagine the new incentive-based compensation rule was already in place and consider how it would work.

The rule’s most stringent requirements apply to “level 1” financial institutions like Wells Fargo with over $250 billion in consolidated assets. Its provisions cover all employees who receive incentive-based compensation, with enhanced requirements for individuals referred to as senior executive officers and significant risk takers.

As head of a major business line, Tolstedt would qualify as a senior executive officer, and her compensation would be subject to:

  • higher minimum deferral requirements – the percentage of incentive-based compensation that cannot be cashed in until the passing of a specific amount of time (meant to encourage long-term thinking);
  • forfeiture of “unvested” compensation (that is, compensation that has been awarded but has yet to be fully transferred to the employee); and
  • clawbacks for so-called vested compensation that has already been transferred to the employee.

Since Tolstedt is retiring soon, the rule’s minimum deferral requirements are less relevant here. But for past performance periods, unvested compensation could be forfeited and vested pay could be clawed back.

Even if one generously assumes Tolstedt was unaware of the fraud taking place, she was still likely responsible for setting the sales goals and compensation structure that incentivized so many employees to defraud customers. Indeed the firm’s own filings with the SEC seem to confirm this. Using these assumptions and applying the text of the proposed rule, it is clear that nearly all of her unvested incentive-based compensation could be forfeited, and her vested compensation could also be at risk of being clawed back.

The proposed rule identifies several types of events that would require covered firms to initiate a forfeiture review. Those most relevant in the Wells Fargo situation include:

  • inappropriate risk-taking, regardless of the impact on financial performance;
  • material failures of risk management or control; or
  • noncompliance with statutory, regulatory or supervisory standards that results in enforcement or legal action against the covered institution brought by a federal or state regulator or agency.

The proposal leaves it to the firm to determine the amount to be forfeited, provided it can support its decisions.

The standards that trigger a review of whether vested compensation should be clawed back are higher (though firms can loosen them). Such situations include a senior executive officer engaging in misconduct that results in significant financial or reputational harm to the institution, fraud or intentional misrepresentation of information used to determine the employee’s incentive-based compensation.

Based on the facts as we currently know them, it would be difficult to prove Tolstedt met the rule’s clawback criteria, since it’s not known if she actually engaged in the fraud herself. If she had, all of the incentive-based compensation that had vested since the fraudulent activity began would be subject to being clawed back.

‘Standard-bearer of our culture’

Assuming the rule was currently in effect, and Wells Fargo was adhering to it, how much would Tolstedt stand to lose?

This is almost impossible to determine given that she has worked at the firm for 27 years, we don’t know how long the fraudulent activity went on for, publicly available information on her compensation is limited and the rule leaves it up to the firm to determine the dollar amount that is forfeited and/or clawed back.

The Consumer Financial Protection Bureau’s Wells Fargo ruling indicates the “relevant period” lasted from Jan. 1, 2011, to Sept. 8, 2016. Over that time frame, Tolstedt received at least $36 million in incentive-based compensation, compared with $8.5 million in base salary.

Under the terms of the proposed rule, Wells Fargo would be able to get back at least half of the $36 million. If Tolstedt was found to have known about the fraud taking place within her division, they could likely get it all back.

When the firm announced in July that Tolstedt would be retiring at the end of the year, Stumpf referred to her as a “standard-bearer of our culture” and “a champion for our customers.” At the time, the firm was winding down its five-year employee purge.

Knowing what we know now, Stumpf could have easily fired her and attempted to claw back a significant amount of her pay. Instead he chose loyalty to a long-time employee over loyalty to his customers. Next time that choice may be off the table.

Author: Lee Reiners, Director of Global Financial Markets Center, Duke University

Deutsche Bank Looks to Settle US Mortgage Legal Exposure at a Reasonable Cost – Moody’s

According to Moody’s on 15 September, Deutsche Bank AG announced in a filing that it has commenced negotiations with the US Department of Justice (DoJ) aiming to settle civil claims in connection with the bank’s underwriting and issuance of residential mortgage-backed securities (RMBS) and related securitization activities between 2005 and 2007. Eliminating the claims’ litigation tail risk at a manageable cost would be credit positive for Deutsche Bank, but negotiations have just begun and the final cost of settlements of complex capital markets litigation remains very difficult to predict.

At the end of the second quarter of 2016, Deutsche Bank had €5.5 billion of litigation reserves, for a variety of legal matters, but the bank has not disclosed the size of reserves for any specific action. For the analysis below, we have assumed that at least half of the litigation reserve could be made available for a possible DOJ settlement. If Deutsche Bank can eliminate this tail risk and settle within or near the assumed reserve of €2.75 billion (or $3.1 billion), it would be positive for bondholders.

Deutsche Bank has indicated its willingness to consider settlements at a cost broadly in line with peers’ prior settlements. However, as Exhibit 1 indicates, peers’ settlements have varied widely, ranging from $1.7 million to $8.9 million per basis point of RMBS league table share. Based on Deutsche Bank’s 6.4% market share, a settlement in the low end ($1.7 million per basis point) or even at the mid-point ($3.6 million per basis point) of the settlement range would be well covered by our assumed DOJ settlement reserve. However, a DB settlement at the high end of announced peer settlements ($8.9 million per basis point) would total $5.7 billion. A settlement of $5.7 billion would require an addition to our assumed DOJ settlement reserve of €2.4 billion, which would dent 2016 profitability (pretax earnings for first-half 2016 totaled €1 billion), a credit negative. Basing litigation exposure solely on market share is a crude approximation, but it helps dimension the adequacy of reserves and potential income statement effect.

db-moodys

The commencement of these negotiations is not surprising since Deutsche Bank management set a strategic objective to resolve crisis-related litigation and remove uncertainty hanging over the bank. As the complex negotiations proceed, we also expect that management have strong incentives to resist a quick settlement with the DOJ that is more expensive than the prior settlements of peers. These incentives include preserving flexibility with respect to paying coupons on its additional Tier 1 (AT1) securities. Even a settlement requiring an additional $2.4 billion of reserve should still leave Deutsche Bank with sufficient flexibility to pay its 2017 AT1 coupons. We expect this flexibility to increase given the EBA’s announced intention to bifurcate Pillar 2 capital requirements into required and guidance components, with only the required component factoring into the calculation of the Maximum Distributable Amount for AT1 coupon payments.

Finally, Deutsche bank’s current Baa2 rating and stable outlook already incorporates the possibility of a modest loss (and substantial litigation costs) in 2016 and the potential for limited profitability in 2017.

“Cosy” Terms of Reference For Big Four Banks Hearings

The Government has released the terms of reference which will govern the appearance of the big four banks before the Standing Committee On Economics.

Bank-Graphic

The Treasurer has asked the committee to hold public hearings at least annually with the four major banks focusing on:

  • domestic and international financial market developments as they relate to the Australian banking sector and how these are affecting Australia
  • developments in prudential regulation, including capital requirements, and how these are affecting the policies of Australian banks
  • the costs of funds, impacts on margins and the basis for bank pricing decisions, and
  • how  individual banks and the banking industry as a whole  are responding to issues previously raised in Parliamentary and other inquiries, including through the Australian Bankers’ Association’s April 2016 six point plan to enhance consumer protections  and  in response to Government reforms and actions by regulators.

Given the aim of the appearances was to counter calls for a Royal Commission on the finance sector, they do appear very gentle. Whilst there are some culture-related issues being handled by the ABA’s internal processes, sharper question about remuneration practices, complaints as well as structural and organisational issues should be on the agenda, if the sessions are to have teeth. For example:

  • How does the vertically integrated business structures, across banking, wealth and insurance, and from advice through to sales and service (both via internal and third party channels) impact consumer outcomes?
  • Do commission arrangements degrade the quality of advice, product fit and price consumers receive?
  • What are the root causes of the recent raft of poor practice and complaints. What is being done to address them?

The committee does include cross-party representation, but with a noticeable bias towards the current governing parties!

The voice of smaller competitors and consumers of bank services will not be heard though this process.

It all feels rather cosy!

ABC 7:30 Does Lenders Mortgage Insurance

7:30 did a segment tonight on Lenders Mortgage Insurance (LMI). As we discussed in an earlier post there are a number of issues which make LMI a complex area.  The segment includes comments from DFA.

Households wising to borrow at an LVR above 80% will be required to pay a significant insurance premium to get a mortgage – Lenders Mortgage Insurance. This extra cost may be bundled into their overall mortgage, or will be a large additional cost.

Many households are not clear on what is truly covered by the LMI in case of default. Whilst LMI may protect the bank, households are not necessarily protected.

In addition, the costs of LMI are not necessary transferable, and there are some industry concentration risks caused by the limited market of providers, over and above the captive insurers within the banks.

 

 

ASIC releases guidance on review and remediation

ASIC has released guidance on review and remediation conducted by Australian financial services (AFS) licensees providing personal advice to retail clients.

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This follows Consultation Paper 247 Client review and remediation programs and update to record-keeping requirements (CP 247), issued in December 2015 (refer: 15-388MR).

The guidance reflects work done with industry over the past several years where ASIC has worked with advice licensees with large remediation programs to shape the scope and nature of remediation arising from systemic advice issues.

The key principles set out in the guidance are:

  • review and remediation is likely to be appropriate where a systemic issue has occurred that may have caused loss or detriment to clients
  • the scope of review and remediation should ensure it covers the right advisers, the right clients and the right timeframe
  • the process of review and remediation should be comprehensive, timely, fair, and transparent. There should be clearly defined principles to guide the process and an appropriate governance structure
  • effective, timely and targeted communication is key to ensuring that clients understand the review and remediation and how it will affect them; and
  • clients should have access to an EDR scheme if they are not satisfied with the remediation decision made.

‘ASIC wants to ensure that advice licensees proactively address any systemic problems caused by their conduct and, where necessary, put processes in place to remediate their clients for loss suffered in a way that is timely, fair and transparent,’ ASIC Deputy Chairman Peter Kell said.

‘Advice firms that take effective and timely steps to fix problems if something goes wrong will be much better placed to retain the trust and confidence of their clients,’ said Mr Kell

In the 2015-16 financial year, ASIC secured over $200 million in compensation and remediation for financial consumers and investors across the areas it regulates.

While the guidance is directed at licensees who provide personal advice to retail clients, review and remediation takes place in many other sectors of the financial services industry. The principles set out in the guidance should be applied to other review and remediation where relevant.

ASIC will shortly release an amendment to Class Order [CO 14/923] Record-keeping obligations for Australian financial services licensees when giving personal advice together with a report summarising the key feedback ASIC received in response to CP 247, and our response to that feedback.

Wells Fargo Bank fined $100 million for widespread unlawful sales practices

According to the US Consumer Finance Protection Bureau (CEPB), hundreds of thousands of accounts secretly created by Wells Fargo Bank employees has led to an historic $100 million fine.

Complainy

Today we fined Wells Fargo Bank $100 million for widespread unlawful sales practices. The Bank’s employees secretly opened accounts and shifted funds from consumers’ existing accounts into these new accounts without their knowledge or permission to do so, often racking up fees or other charges.

The Bank had compensation programs for its employees that encouraged them to sign up existing clients for deposit accounts, credit cards, debit cards, and online banking. According to today’s enforcement action, thousands of Wells Fargo employees illegally enrolled consumers in these products and services without their knowledge or consent in order to obtain financial compensation for meeting sales targets.

Bank employees temporarily funded newly-opened accounts by transferring funds from consumers’ existing accounts in order to obtain financial compensation for meeting sales targets. These illegal sales practices date back at least five years and include using consumer names and personal information to create hundreds of thousands of unauthorized deposit and credit card accounts.

The law prohibits these types of unfair and abusive practices.

Violations covered in today’s CFPB order include:

  • Opening deposit accounts and transferring funds without authorization, sometimes resulting in insufficient funds fees.
  • Applying for credit-card accounts without consumers’ knowledge or consent, leading to annual fees, as well as associated finance or interest charges and other late fees for some consumers.
  • Issuing and activating debit cards, going so far as to create PINs, without consent.
  • Creating phony email addresses to enroll consumers in online-banking services.

 Enforcement Action

Under the Dodd-Frank Wall Street Reform and Consumer Protection Act, we have the authority to take action against institutions that violate consumer financial laws. Today’s order goes back to Jan. 1, 2011. Among the things the CFPB’s order requires of Wells Fargo:

  • Pay full refunds to consumers.
  • Ensure proper sales practices.
  • Pay a $100 million fine.

Today’s penalty is the largest we have imposed. Other offices or agencies are also taking actions requiring Wells Fargo to pay an additional $85 million in penalties.

In a discussion on the Knoweldge@Wharton site, they highlight this may not be a one off. The “cross sell” business model underpinning banking is to blame.

More Banks May Be Involved: “It’s not just Wells Fargo,” says Cook. “Fees are a critical part of the profit model for banks in the U.S.” Conti-Brown agrees, and says the practice of cross-selling brings in the fee income that banks badly want. “Cross-selling is one of the reasons Wells Fargo is said to be so successful,” he says of the bank, which along with its parent of the same name, controls some $1.9 trillion in assets. “The [bank’s] incentive structure is flawed,” he says, explaining that deviant practices could occur if top management ties employee rewards to signing up existing customers to more products and services.