Financial Regulation Update – 23 November 2018
2018 has been a watershed year for financial regulation. In early November, the FMA and RBNZ released findings from their joint review of bank conduct and culture in New Zealand retail banks (NZ Review). This follows the interim report of the Australian Royal Commission (ARC Interim Report) and the APRA Prudential Inquiry into CBA (APRA Inquiry) which were released earlier this year. Similar themes emerge from each of the reports.
In the NZ Review, the FMA and RBNZ concluded that conduct and culture issues do not appear to be widespread in New Zealand banks. However, they raised concerns about the lack of proactivity in identifying and remediating conduct issues, and identified weaknesses in the governance and management of conduct risks.
Individual banks will be provided with detailed findings so that they can understand what improvements they need to make. Each bank will be required to develop a plan to address FMA/RBNZ feedback and report their progress by March 2019.
The findings in the NZ Review are divided into four themes. We have used these themes as a starting point and address them below, together with relevant insights from the APRA Inquiry and ARC Interim Report.
To a large extent, the themes apply beyond the financial services industry and represent a blueprint for all companies who deal directly with the public and wish to improve their customers' experience – and conversely, to mitigate conduct and culture risk.
Delivering good customer outcomes
Hear the voice of the customer
Both the NZ Review and the APRA Inquiry point to the need to hear the "voice of the customer". This can be done by:
- establishing formal product design processes involving product, marketing, digital, risk and legal staff; and
- simplifying the type, number and features of products available.
Strong systems and controls are required to ensure that customers receive products that meet their needs. This includes having appropriate controls to:
- prevent errors, breaches of approved limits or deliberate misuse of systems and products; and
- investigate and verify the financial position of customers in credit assessments. The ARC Interim Report raised concerns about banks relying on minimum expenditure benchmarks. The FMA/RBNZ Review was limited in this respect, but information that relates to the banks' adherence to the Responsible Lending Principles will be shared with the Commerce Commission, and the RBNZ will review banks' lending standards.
In the ARC Interim Report, concerns were highlighted about whether intermediaries act in the interests of the customer or the bank. FMA/RBNZ consider that more work is required to ensure that good customer outcomes can be delivered through intermediaries.
Customer outcomes will need to be measured over both the short and long term. Like APRA, FMA/RBNZ did not consider use of the Net Promoter Score sufficient to measure customer outcomes. Instead, management and boards should consider what good customer outcomes look like for each part of their business and measure how they are performing against that definition.
Key message for organisations not subject to the review process: Implement a definition of a "good customer outcome" and a way to measure that over the long term.
Incentives are clearly a big area of concern in the ARC Interim Report, and likewise in the APRA Inquiry and NZ Review. While the ARC Interim Report raised issues and provided no solutions, the NZ Review has been somewhat more specific about what its expectations are with regards to incentives.
Banks will be expected to implement changes to their incentive programmes by the first performance year after 30 September 2019. Banks will also be asked to report on progress in March 2019. Any bank that does not commit to removing sales incentives linked to sales measures for salespeople and their managers will be required to explain how they will strengthen their control systems sufficiently to address the risks of poor conduct that arise with such incentives.
The FMA has undertaken a separate thematic review of the incentive structures of nine of the 11 banks covered by the review, and has also recently published its report on this topic, which addresses these findings in much greater detail.
Key message for organisations not subject to the review process: Assess whether existing incentive arrangements should move away from sales-based remuneration.
Conduct and culture governance
Similar to the ARC Interim Report, the FMA/RBNZ found that reporting about conduct was at an early stage of maturity. Boards did not seem to be receiving sufficient information with which to form a complete picture of conduct and culture issues. There was also a heavy reliance on lag indicators that report historical information, rather than lead indicators, to provide insights on potential outcomes and emerging trends.
As is the case for salespeople, the way that senior management (such as the CEO) is incentivised needs to be structured in a way that drives a focus on conduct and balances short and long term outcomes.
While the APRA Inquiry looked closely at the structure of committees at CBA and identified some key weaknesses such as committees not working cohesively or being led by one key person, the NZ Review of committees appears to be relatively high level. The NZ Review found that many of the committees were new, and so it was recognised that it would take time for these structures to be embedded.
Key message for organisations not subject to the review process: Make "conduct and culture" a standing item on board agenda and require proactive reporting.
Conduct and culture risk management
The NZ Review found that risk management frameworks in New Zealand banks are still in their early stages, and that gaps in such frameworks (such as conduct committees without formal decision-making powers) need to be addressed. Improvements are required to the mechanisms available for staff to report and escalate issues. Formal reporting mechanisms such as whistleblowing processes are rarely used.
Most staff interviewed said they would feel comfortable raising concerns and issues informally, which is consistent with FMA/RBNZ's expectation that banks foster a "no-blame, speak-up" culture. However, as no evidence of staff using informal channels was able to be provided, concerns were raised that the policies that encourage staff to speak up about conduct and culture issues were not effective. The findings from the APRA Inquiry, where it was found that collegiality and high levels of trust led to a lack of healthy constructive challenge, also emphasise the difficulty of creating the ideal culture.
The NZ Review found large variances in the training and support available for staff, with some banks investing heavily and others providing minimal training. There is the opportunity for improvements to staff training in order to ensure good outcomes for customers are delivered.
Key message for organisations not subject to the review process: Make conduct and culture risk an effective component of your risk management framework.
Issue identification and remediation
The NZ Review found that many banks required improvements to their processes to identify and remediate issues. There was variability in how customer complaints were recorded and how complaint processes were implemented. One reason for the variability was the lack of a common definition of "complaint". In this respect, FMA and RBNZ believed that organisations such as the Banking Ombudsman and the New Zealand Bankers Association could play a greater role in driving consistency and raising customer awareness of complaint and dispute resolution processes.
There is an opportunity to use customer complaints to proactively identify emerging trends and address issues that may require remediation. FMA and RBNZ considered that boards should seek positive assurances from management about customer outcomes rather than rely on the absence of reported issues To borrow from the APRA Inquiry's findings, an attitude of chronic unease should be adopted, which holds senior management to account through a "don't tell me, show me" philosophy.
Of the 11 banks, four did not identify any issues requiring remediation. FMA and RBNZ considered that this reflected weaknesses in the systems and processes for identifying and recording issues, a lack of effort in identifying issues, or a lack of understanding about how misconduct may arise.
Many of the issues requiring remediation occurred as a result of underinvestment in systems and reliance on manual processes. This point was also raised in the ARC Interim Report, where in some cases the inadequacy of systems contributed to fees being charged for no services.
Key message for organisations not subject to the review process: Implement a customer complaints process that is clear, consistent, seeks to identify long-term trends, and involves reporting to the board.
Click here for links to the NZ Review, ARC Interim Report and APRA Inquiry. Please get in touch if you would like to discuss how the findings from the various reports may be relevant to you and your organisation.