Recommendations of the Royal Commission: Are they going far enough?
In December 2017, the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry was established. On 4th of February 2019, the Commission tabled is Final Report to Parliament. Investigations found evidences for industry-wide misconduct. Key drivers were greed, asymmetric distribution of knowledge & power, unresolved conflicts of interest and lax enforcement of the law.
To address these findings, the Royal Commission makes 76 distinct recommendations. They are designed to prevent future misconduct and to increase consumer protection. Stated objectives are:
- simplification of the law eliminating room for interpretation
- removal of conflicts of interest
- re-focus of regulatory activities on deterrence of misconduct
- improvement of governance, culture and remuneration practices in the financial service industry
With the Final Report submitted to Parliament, the question arises how and to what extent the government as well as the financial service industry will implement outlined changes. Treasury already accepted all recommendations and promised appropriate actions. Changes to the law, regulatory approach and increased supervision with special focus on governance, culture and remuneration practices can be expected.
However, in its Final Report the Commission raises concerns about players in the financial service industry. During various hearings, it found that at least some organisations displayed a certain unwillingness to accept responsibility for misconduct and for provision of services in an efficient, honest and fair manner. The Commissioner singles out NAB which treated fees for no service as a mere administrative error and even urged sales staff to sell at least five mortgages before Christmas 2018. Following the publication of the Report, both the Chair of the Board and CEO resigned “voluntarily”.
The Final Report makes specific and interlinked recommendations to address the identified misconduct. However, do these suggestions go far enough to initiate a profound change in the Australian financial service industry?
Codes of Conduct
Over the past years, banking, financial advice, insurance and superannuation each had a Code of Conduct – written by industry members for industry members. These Codes of Conduct contained promises to the customer. However, cases discussed during the Royal Commission illustrated colourfully that these Codes appeared to pay lip service to expectations but breaches had no serious consequences. While the recommendations in the Final Report try to address this, some additional aspects need to be considered.
- Past attempts of self-regulation evidently failed. What is changing that a new attempt of self-regulation has more chances of success?
- In addition, associations are funded by members of the industry and in fact, comprise major financial institutions – some with past misconduct cases. What is the likelihood that these associations will agree to and enforce a Code of Conduct containing requirements potentially detrimental to member organisations?
- So far, these Codes of Conduct could be adopted voluntarily. An organisation not adopting the Code of Conduct would still be in a position to prey on customers, i.e. to maximise its profits to the detriment of customers. Outside of making it a regulatory requirement, how will such organisations be incentivised to focus on customer outcomes and address community expectations?
Exceptions to the Law
Some recommendations of the Final Report aim at eliminating exceptions to the law. However, reviewing current exceptions to the law, it appears that industry lobby groups were very successful in carving out concessions for their respective niches.
This raises the question what will change in future to prevent these carve outs in one, three or five years?
The Final Report confirms the “twin peak” regulatory approach of APRA and ASIC. It even goes as far as saying that capabilities of both regulators need to be assessed regularly. In addition, the Report recommends that regulators adopt BEAR for their senior management personnel. These recommendations indicate that organisational structures need to be revised and potential “outside” talent hired in order to enhance the regulatory approach.
However, Australia has a limited talent pool which has been grazed by the financial institutions and large consultancies already. That poses various challenges:
- The financial service industry can afford the best and brightest who are paid to find the best way of making money for the organisation. Where can the regulators find talent willing to work for them and capable of “supervising” the financial institutions?
- Can a case be made to acquire the necessary budget to hire such talent?
- Identifying and employing such talent requires the right hiring policies. Are these hiring policies in place already or do they need to be established first?
As mentioned earlier, the Commission found that some organisations were unwilling to accept responsibility to provide services in fair, honest and efficient manner. Looking at saving products of the big four banks, maximisation of profits still appears to be at the forefront of product design and sales practices.
For existing customers each bank offers a saving account with a moderate interest rate of 0.5% (as of 02/2019). Considering the current inflation rate, any deposit in such a savings account would result in a decrease of asset value over time even though the product name suggests growth.
In addition, new customers can take advantage of a promotional rate which is about 2% higher than the interest rate offered to existing customers. The clear message is: new customers are more valued than loyal customers – contrary to public statements.
Furthermore, it appears that the promotional rates are designed to acquire new business in the hope that customers forget to look for a better deal after expiry. This results in “cheap” funding for the banks, i.e. they only have to pay 0.5% interest rate on deposits in the long-term.
While the Final Report does not contain any specific recommendations for product design and sales practices, it remains to be seen whether regulators will increase their focus on fairness, honesty and efficiency in relation to product design as well as subsequent sales practices. That would mean financial institutions are forced to focus even more on customer outcomes.
If implemented, recommendations of the Royal Commission will have a positive impact on customer outcomes. However, some open questions remain around:
- Effectivity of Codes of Conduct
- Long-term alignment of customer outcomes and influence of industry lobby groups
- Resourcing of regulators
- Consumer protection including product design and sales practices