Good conduct is good business
20 October 2022,
Sarah Inglis, Principal Consultant – Mosaic Financial Services Infrastructure
A UK think tank study in 2014 estimated that between 2010-2014, 25% of UK banks’ (ref. 1) pre-tax profits were attributed to consumer redress and associated administration costs.
This same review identified that 3 of the 5 largest had retail misconduct costs that were more than dividends.
In New Zealand, we haven’t seen the same level of systemic misconduct as the UK or Australia, but it is clear that financial institutions are also paying for the outcomes of decisions made years ago. Since the 2018 conduct and culture reviews, $150m has been repaid to customers in New Zealand by banks and insurers, addressing more than 200 systemic issues that have impacted 1.5m customers (ref. 2). This does not include the indirect costs of remediation that face the institutions – legal fees, internal and external resourcing, a cost which runs into the millions. In some cases, the costs of remediation are higher than the redress for customers.
While one would think the cost itself would be enough to take pause to consider how a customer-centric approach could benefit a bottom line, regulators around the world are taking action to force the hand of financial institutions, some of whom for years have been driven by a culture of sales, profits and bonuses. Some regulators have taken a prescriptive approach, New Zealand is approaching it with a principles-based regime, with the expectation that financial institutions will embed a fair conduct principle into the way products are designed, managed, sold and customers treated. What this looks like in practice, well that’s up to the financial institution to decide. What does good look like?
Is there such a thing as Minimal Viable Product (“MVP”) when it comes to conduct?
Without prescriptive obligations, it is up to leadership to decide, and it’s not easy. What looks fair to one person, might feel like gold plating to others. The way one person might expect an organisation to support customers experiencing vulnerable circumstances might be too far for others. We can look to overseas legislation for guidance, but one size won’t fit all. Each financial institution will need to put in place policies, processes, systems and controls that are appropriate for their size and complexity, and the unique features of the New Zealand market. Financial institutions need to ensure that organisational and customer interests align.
The link between reputation and conduct is clear even it if is difficult to quantify. The 2018 Global RepTrak report (ref. 3) identified 2 of the top 3 drivers of how a firm is perceived in the market are directly related to conduct and behaviour. These top 2 drivers encompass firstly, the quality and value of products and services and the servicing of customers and secondly, governance – being open and transparent, ethical and fair in doing business. The latter speaks directly to the Fair Conduct Principle the FMA is expecting to see embedded in financial institutions here in New Zealand. It is therefore hard to argue against having a robust Fair Conduct Programme in place as it will be a driver for building and protecting a strong reputation.
Strategic decisions need to consider long-term impacts to customers, that consider the future proofing of products and services, technology and customer outcomes and set the foundations for an organisation that is focused on fair customer outcomes. With the average CEO tenure being about 4 years (ref. 4) and bonus structures looking 2-3 years into the future, the challenge will still be in aligning short to medium term interests with long-term customer outcomes.
While there is a clear link between the fair treatment of customers and better financial outcomes, is there an argument that it just the cost of doing business?
The Starling Trust’s Deeper Dive into Misconduct (reference 5) sets out that bad apples will continue to misbehave and those that are well-meaning, if careless, will continue to make mistakes with serious consequences. Controls will fail. Action will be taken against misconduct, fines levied, civil penalties and costs associated with customer remediation is inevitable. Both regulators and firms are becoming increasingly resigned to treating misconduct as a cost of doing business. Estimated costs are provisioned for in financials and are effectively priced into an institution’s value. Perversely, there have been occasions where share prices have increased in response to a substantial fine, after creating certainty around a regulatory outcome.
Regardless of any institutional acceptance of the costs of misconduct being inevitable, one would hope that in more recent years, these costs are related to historical or legacy issues, such as poor control environments, technology and culture – consequences of short-term thinking and decisions made that did not have fair customer outcomes at their heart. To continue with such an approach, to retain the status quo is unsustainable. The costs to society can’t be priced into a share price, nor can a long-term loss of trust in the financial services industry.
There is some positive change. Financial institutions, in response to the FMA conduct and culture reviews, are taking actions to change organisational culture, invest in the future, acting in long-term interests of both their customers and shareholders.
And while not all misconduct costs can be mitigated – as the Starling Trust Deep Dive observes, there are always bad apples and control failures, having well designed products and supporting customers through their journey with the institution will ultimately impact positively not only on the bottom line, but support a more sustainable financial services industry.
For New Zealand, as we prepare for the Conduct of Financial Institutions licensing regime, financial institutions need to be looking at how to genuinely embed the Fair Conduct Principles across the lifecycle of the products their organisation provides to its customers, and leverage the opportunity that sits in front of them – that a strong conduct programme and a culture that prioritises fair customer outcomes will reduce the costs associated with poor conduct practices, delivering and sustaining a strong market reputation alongside the bottom line.
How Mosaic can help
Mosaic has a team of risk and compliance experts with conduct experience to work pragmatically with you to assess and uplift your conduct practices from design to implementation. Get in touch with one of our Partners or Consultants to discuss how Mosaic can support you.