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Time for retail banking to step up

by Matthew Smith | 04 May 2017

#1 Time for retail banking to step up

Unwinding the sales culture within the banks’ mortgage-broking businesses won’t be easy, but it can be done.
 
Senior professionals on FINSIA’s Retail and Business Banking Industry Council this week weigh in on findings and recommendations of the so called “Sedgwick Report”, the culmination of the industry’s year-long investigation into its own remuneration practices in retail banking.
 
Steve Sedgwick, the leader and adopted namesake of the Retail Banking Remuneration Review is the unflappable career public servant — most recently he was the Australian Public Service Commissioner; prior to that he was the Secretary to the Commonwealth Departments of Finance, Employment and Education; before that, a Professor and Director of the Melbourne Institute of Applied Economic and Social Research at the University of Melbourne.
 
The review — independent and industry funded — cuts straight to the core of where regulators and critics of the industry believe banks’ culture is being strangled by its legacy sales culture.
 
The Australian Securities and Investments Commission has recently called out what it describes as a conflicted remuneration structure within the mortgage broking industry.
 
Meanwhile, the Reserve Bank of Australia has been highlighting the importance of mortgage loan standards set by the prudential regulator in the context of the banking system’s stability.
 
The Sedgwick Review is the industry’s opportunity to address its most obvious problem before the matter is taken out of its own hands and calls for a Royal Commission into the banking industry begin to echo louder.
 

Culture reset

What Sedgwick lays out in his final report is enough, if taken on board by the industry — not just in principle, but with the thoroughness and depth intended. It should mark the beginning of a new era in banking culture where the tone for what customers expect of their financial institutions can be set.
 
Getting this culture right could be the biggest advantage incumbent financial institutions have over the new upstart financial services providers of tomorrow currently germinating within our busy fintech incubators, the professionals on FINSIA’s Retail and Business Banking Industry Council, agree.
 
Financial institutions enjoy a certain level of trust of customers today, but that trust has the potential to be eroded by the sales culture highlighted recently by regulators, particularly when new competitors emerge in this space, the professionals muse.
 
“Banks that do have that sales culture will not win in the long run,” says Allan Hodgson, a professor in accounting and finance and University of Queensland and a senior member of the council.
 
Hodgson highlights research from the United States which shows banks that were highly profitable leading up to the global financial crisis are now less profitable than their more traditional banking peers.
 
“When you have a sales dominated culture, it extends right to the tone at the top — banks in the US and in the UK which were more sales oriented might do well in the short run but not in the long run,” Hodgson comments.

Wrong culture

One of the findings central to the Sedgwick review as well as previous ASIC reviews is that commission payments to mortgage brokers form a significant part of individual’s salary, in some cases it finds the commission component can be bigger than the fixed salary.
 
“That’s not the right culture,” Hodgson notes.
 
The Sedgwick Review came up with 21 recommendations that predominantly address issues relating to performance management, governance and culture.
  
“The report states that public trust in the banking sector has declined both in Australia and elsewhere”, Janine Copelin, Citi Australia’s Retail Bank head and managing director, summarises.
 
“I believe the implementation of the recommendations will assist in helping to restore this trust,” Copelin says, in conversation with InFinance.
 
“Customers rightly expect their bank to do the right thing and it’s critical that industry level remuneration structures are refined to reflect this expectation — i.e. ensure that staff are incentivised to always obtain the best possible outcome for their customers,” Copelin says.
 

Rethinking incentives

One area the banks now need to push further, beyond the recommendations of the report, is to come up with a better way to measure and reward performance, notes Harald Scheule, an associate professor of finance at the University of Technology, Sydney.
 
While the Sedgwick Report suggests replacing a direct link of remuneration to volume sales with a range of broader factors — including such things as customer satisfaction — where it possibly doesn’t go far enough is suggesting banks link the risk sensitivity of loan products to broker remuneration, Scheule explains.
 
"Following the report I would expect banks to include more detailed proxies for profitability or bank value creation other than sale volume. There is scope here to also link remuneration to the risk of financial products,” Scheule says
 
Scheule highlights the work that’s already been done by prudential regulators such as the practice guidelines on residential mortgage lending by the Australian Prudential Regulatory Authority, which he outlines here.
 
Based on his own research, Scheule notes that banks should charge higher risk borrowers an increased rate, and adjust the remuneration it is prepared to pay the broker originating higher risk loans and other products.
 
Scheule notes that the measurement of risk is challenging and will require banks to think hard about the kind of systems they set up to address the Sedgwick recommendations.
 
“The Sedgwick Report explicitly mentions the loan to value ratio (LVR) of mortgage loans as one example. One other, perhaps more direct, option might be to release broker fees after some time that the loans have not experienced impairments,” he outlines.
 
“I believe that more risk-sensitive pricing will become reality as it provides for a more  resilient and efficient financial system,” Scheule says.

Over to the banks

Taking on the recommendations of the review will require the banks to be more clear about how to measure the customer expectation part, UQ’s Hodgson notes.
 
“These are profit-making institutions answerable to shareholders, the report itself was very vague on how they will measure the profits with the customer side while fulfilling their duty to shareholders on the other side,” Hodgson comments.
 
Whether the banks are up to the task of taking on the Sedgwick recommendations remains to be seen, although all of the banks quickly endorsed the Sedgwick Report findings after it was published.
 
Industry-led independent reviews have in the past been called out for having all the best intentions but not delivering in the end, an outcome that neither good for customers or the industry which will invariably face a less favourable review process the next time around.
 
Former APRA executive member and author of the Trowbridge Report, the very first private sector industry-funded independent review into life insurance commissions and remuneration structures has expressed his issue with industry-led independent reviews in this forum.
 
With the Sedgwick Review complete, it’s not up to the banking industry to prove its genuinely serious about leaving its legacy retail banking sales culture in the past where it belongs.

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  • | May 04, 2017

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