By Gareth Vaughan
A report by New Zealand's two key financial markets regulators into the conduct and culture of our banks suggests ultimately banks do what's best for banks, with this not necessarily coinciding with what's best for their customers, the majority of whom don't trust the banking industry.
The report, which does not attribute findings to individual banks, highlights "a small number" of issues related to poor conduct by bank staff, with issues relating to system or process weaknesses most commonplace. Based on their findings, the FMA and RBNZ conclude conduct and culture issues do not appear to be widespread in NZ banks at this point in time.
Nonetheless the regulators say they are concerned about bank's lack of proactivity in identifying and remediating conduct issues and risks in their business.
"More broadly, we identified weaknesses in the governance and management of conduct risks. This is a vulnerability that, if left unchecked, has the potential to lead to widespread issues," the FMA and RBNZ say.
"Our review confirmed that all 11 banks need to more effectively identify, manage, remediate and report on conduct risks and issues, to deliver consistently good outcomes for customers. Banks need to proactively work to achieve maturity in this area."
The regulators note that some banks' product review processes are "primarily focused on how the product benefits the bank, rather than customers." They say this reduces the likelihood key risks posed by their products will be detected and remediated. The regulators even point out that there's no common definition across the banking industry of what constitutes a complaint.
The report includes a number of recommendations to improve oversight, controls and processes. Bank boards and senior management are told to "ensure these improvements are made with a sense of urgency," with the regulators adding these measures will prove unsustainable if a bank does not have a truly customer-focused culture.
“The governance of conduct risk in the banks requires serious attention. Boards and senior management must address the recommendations and findings from our review with urgency. The FMA published a guide to good conduct in February 2017, but some banks have only now started to consider these issues, with most of the initiatives not going deep enough,” FMA CEO Rob Everett says.
Everett says only six of 11 banks had analysed their conduct and associated risk frameworks against the FMA's 2017 Conduct Guide prior to this FMA and RBNZ review. This is despite such analysis being strongly encouraged by the regulator when the guide was published.
RBNZ Governor Adrian Orr says: “To promote a sound and efficient financial system, banks have a responsibility to ensure customers receive products and services they understand. These products and services must be suited to customers’ needs on an ongoing basis. Failure in this responsibility exposes customers, banks, and the wider economy to unnecessary risk – as dramatically demonstrated by the recent Global Financial Crisis.”
The FMA and RBNZ conclude that the overall standard of banks' approaches to identifying, managing and dealing with conduct risk needs to improve markedly.
Most customers don't trust the banking industry
A survey conducted as part of the review found that about two-thirds of people trust their own bank to meet their needs, but only 42% trust the banking industry as a whole.
Additionally the survey showed:
• 69% of people agreed that bank staff tailor advice or recommendations to their needs, but only 44% felt bank staff put their long-term financial interests first.
• 24% of respondents agreed that their bank’s staff had offered them products they didn’t want or need. The results for individual banks ranged from 7% to 15% for small banks, and from 25% to 30% for large banks.
• Following on from this, 15% of people agreed bank staff had tried to pressure them into buying unwanted financial products. The range of results for individual banks was again wide, ranging from 3% for one bank to 21% at another.
• 4% of people had made a complaint to their bank in the past year and an additional 6% said they had felt like making a complaint but decided it was too much effort.
The regulators say NZ banks are well positioned to make the required changes.
"Following this report we will be expecting to see much deeper accountability of boards, executives and senior managers. We will be looking for progress and clear evidence of change, and want to see this become part of the ethos of all banks in New Zealand," the FMA and RBNZ say.
The bad behaviour the regulators found
The nitty-gritty, in terms of bad behaviour the regulators did discover, includes more than 50 remediation activities in progress or recently completed.
"For remediation issues where banks had estimated the financial impact, an estimated 431,000 customers had been impacted, at a total estimated remediation cost of $23.9 million. There are a number of remediation activities under way where the impact on customers is yet to be determined."
They say the four biggest remediation activities underway, based on customer numbers, affect a combined total of 336,000 customers, with a total estimated remediation cost of $12.7 million. Each of these issues is estimated to affect between 60,000 and 110,000 customers. However, the estimated average cost impact per customer is between just $5 and $100.
"The majority of issues appear to have been caused by system or process weaknesses, or processing errors. It is concerning how relatively commonplace these problems are. These system and process issues resulted in a broad range of impacts on customers, including the following:
• Incorrect disclosure of fees or interest.
• Changes to fees not applied consistently to new and existing customers.
• Incorrect interest rates applied to credit cards.
• Fee waivers not applied consistently.
• Loyalty points for credit cards awarded incorrectly or not at all.
• Potentially inappropriate unsolicited offers of credit sent to customers.
• Customers not receiving new credit or debit cards due to the postal address being incomplete in the systems.
• Interest rate changes not implemented correctly.
• Inaccuracies in customer transaction records and statements."
The FMA and RBNZ note these problems are occurring across most banks and the low average financial impact per customer could change as banks continue to work through the assessment and remediation of issues. Key factors contributing to these issues are underinvestment in systems, and reliance on manual processes to compensate for system weaknesses, the regulators say.
"For example, some banks had not made appropriate system changes when introducing product changes or promotions, meaning staff were required to make manual changes. Manual processes are more difficult to oversee, and are more likely to result in errors and omissions. We also identified a small number of issues related to poor conduct of bank staff rather than systems or processes. While fewer customers were affected by these issues, the financial impacts to customers and the banks are potentially larger. Based on the information disclosed by banks, these instances of poor conduct were not widespread. However, we are concerned that the small number of conduct issues identified by banks indicates their inability to proactively identify conduct issues or even understand what poor conduct looks like in their business."
Examples of bad conduct
Examples of bad conduct cited by the regulators include the following examples.
• One bank identified legacy products where the associated fees materially outweighed the benefits to customers. The bank is closing these packages, advising customers and paying refunds where appropriate.
• One bank received complaints about unwanted insurance products. The bank completed an assessment of the usefulness of insurance policies to customers, and is now considering refunds for customers and training requirements for staff.
• One bank discovered that a staff member was excluding relevant information about existing debts from credit applications in order to approve them. The bank has reviewed the staff member’s historical lending approvals and is working with customers to determine whether the lending is affordable, or if changes are needed.
• One bank advised of a recently identified practice within a specific region where staff working at one branch which had met its sales targets were recording their additional sales against the records of another branch in order to help that branch meet its sales targets.
• Staff at one bank manipulated customer records to prevent customers from receiving satisfaction surveys. This happened if it was likely the customer would provide negative feedback, which may have impacted on staff incentive payments.
The FMA and RBNZ's findings are divided into themes based on four aspects of managing conduct and culture. These are; delivering good customer outcomes, conduct and culture governance, issue identification and remediation, and conduct and culture risk management.
In comments on the regulators' report, EY partner and financial services leader Paul Roberts said it was "disgraceful" that only six of 11 banks had, prior to the FMA and RBNZ review, measured their conduct and associated risk framework against the FMA’s conduct guidelines given to the banks in February 2017.
"We see the theme of complacency running right through today’s report, particularly the banks’ lack of proactivity in identifying, assessing and remediating conduct issues and risk," said Roberts.
"Does New Zealand need a banking royal commission? Probably not, but how would you know there are no systemic problems if you don’t have robust processes in place to identify and address them? As today’s review notes, if the complaints data are not strong enough and whistleblowing doesn’t provide the anonymity you would expect, how would you know if you had a problem?" Roberts added.
Short-term focus criticised
The regulators are critical of banks focusing on the short-term measure of customer satisfaction, but doing little to monitor long-term customer outcomes like whether products bought are suitable for customers' ongoing needs. They note banks use a survey tool known as Net Promoter Score to gauge customer loyalty. These are generally done immediately after the customer interacts with the bank - when any harm caused by poor product design or inappropriate sales or advice may not manifest itself for years.
"We do not consider Net Promoter Score or other similar surveys sufficient to measure customer outcomes," the regulators say.
The FMA and RBNZ point to a heavy reliance on lag indicators that report on historical information, such as customer complaints or satisfaction surveys, with banks are not using lead indicators to any material degree.
"Lead indicators can provide insights on potential outcomes and identify emerging trends. For example, analysis of how a customer is using a product may be an indicator of outcomes such as whether the fees the customer is paying are reasonable, or whether they are receiving the intended benefits from the product, the regulators say.
They also point out that across the industry, formal policies and procedures to encourage staff to report conduct and culture issues are not effective and seldom used.
"There was also a general lack of awareness and understanding of both formal and informal reporting channels," the regulators say. "We identified gaps in staff training across many banks."
"Many banks relied on customer complaints to identify issues, but in some cases the systems and processes for recording complaints had serious weaknesses. Processes for staff to raise issues were also generally poor. Combined, these factors limited the ability of banks to identify and deal with issues in a timely manner. In some instances, banks had not approached remediation of identified issues with a sense of urgency," say the FMA and RBNZ.
"Our review identified conduct issues that banks are in the process of assessing and remediating. The majority of issues stemmed from weaknesses in systems and processes, and resulted in impacts such as customers being charged incorrect fees or interest. In some cases, these issues affected large numbers of customers, although the average financial impact for each customer is estimated to be small.
"We observed a small number of issues that were primarily the result of poor conduct of bank staff, rather than system or process weaknesses. Some of these related to inappropriate lending and sales, fees materially outweighing benefits to customers, manipulation of customer records to influence satisfaction outcomes, and manipulation of branch sales records. While we didn’t find evidence to support these issues being widespread, we expect more issues may come to light as banks continue their own work in response to issues arising from the Australian Royal Commission.
"There is a lack of specific regulatory requirements in relation to conduct across the banking sector, particularly in respect of the delivery of banking products distributed without financial advice...However, neither regulator has an express mandate to regulate overall bank conduct," the FMA and RBNZ say.
"The issues identified in this review are not the result of gaps in regulation. The power to make changes rests with the banks, and their desire to change should come from a genuine focus on improving customer outcomes – not the need to comply with the law."
Plan required by April 2019
The FMA and RBNZ say all banks will need to develop a plan to address their regulators' feedback, and report their progress by the end of March 2019. Banks are told to place a high priority on the development and implementation of these plans.
FMA and RBNZ recommendations for the Government to look at to address the current regulatory framework and issues highlighted by the FMA and RBNZ are covered in a separate interest.co.nz article.
Meanwhile, the regulators note some banks indicated their credit assessments incorporate whichever is higher of estimated customer expenses or a minimum expenditure benchmark.
"However, we did not get a good sense of how many loans are approved using these minimum expenditure benchmarks, and how realistic these minimum benchmarks are. We will share information that relates to the banks’ adherence to the Responsible Lending Principles with the Commerce Commission for their consideration. Reflecting its prudential mandate, the RBNZ will review banks’ lending standards in due course."
The challenge of intermediaries
The regulators also note some banks acknowledged challenges with monitoring and managing the conduct of intermediaries such as mortgage brokers. A number of banks highlighted conduct risks associated with their limited oversight of the customer interactions that occur through brokers and other intermediaries, the report notes.
"The Australian Royal Commission interim report highlighted concerns about the roles and responsibilities of intermediaries, in particular whether the intermediary acts in the interest of the customer or the bank, and how the remuneration of intermediaries impacts customer outcomes. While again our review was limited in this area, we found little evidence of banks having enhanced controls and oversight of their higher-risk products and distribution channels. More work is required to ensure banks are comfortable with the quality of conversations and advice that occur via intermediary channels, and that the incentives offered to intermediaries are aligned with good customer outcomes," the FMA and RBNZ say.
A 'no-blame, speak-up' culture encouraged
The report also finds whistleblower policies aren't always well understood by staff, and asks for banks to foster a "no-blame, speak-up" culture. The regulators say formal and informal reporting channels need to be visible to staff, to provide for independent, confidential and effective reporting. Staff also ought to be educated about expectations of good conduct and culture so staff can recognise and report deviations.
"There was a serious weakness in that the policies to encourage staff to speak up about conduct and culture issues were not effective. Most banks need to prioritise making changes to their formal and informal reporting channels. We also see the opportunity for improvements to staff training."
The regulators point out most banks do not have comprehensive processes to systematically and proactively identify potential or emerging issues. Thus to a degree they rely on complaints from customers to identify issues.
"Our consumer survey showed that only 4% of those surveyed had made a complaint to their bank in the past year. Relying on complaints is likely to be insufficient to identify all potential issues requiring remediation. Banks need to develop a ‘no-blame’ culture around customer complaints, to ensure staff feel comfortable raising and recording issues," the regulators say.