Institutional shareholders and insurance sales culture led to banks downfall

It’s easy for CBA to blame Ian Narev. But it was a cocktail of two toxic cultures that undid our once-admired banks.

Left to right, former Commonwealth Bank CEO Ian Narev, chairman Catherine Livingstone and current CEO Matt Comyn. Picture: Britta Campion

How was it that Australia’s bankers went from ranking as among the best in the world to being stuck in a mire where many of them face criminal prosecution? Current CBA chiefs have taken to blaming their former colleagues rather than looking at what really happened.

Multiplying the banking mess, our life-insurance based companies have gone from being respected to trash.

The royal commission has uncovered a multitude of banking and investment management sins but it has never addressed the complex question of how we got to this position. Current CBA chiefs have blamed their bank’s part in the industry failure on former CBA boss Ian Narev. That means that CBA’s board and top management still do not really understand what happened.

Until the current CBA chiefs —-or their replacements —-address the underlying causes they may need heavy-handed regulation to stop them going back to their old ways. That would be economically disastrous. So today I am going to give what will be at least a first attempt at explaining just how our bankers allowed themselves to fall from world ranking into a situation where they are now all saying sorry for being so greedy and stupid and blaming their colleagues rather than looking for the truth.

Sadly, as I delved into what had gone wrong I discovered the sulfurous fumes that engulfed the banking community are also seeping into other parts of the business community.

Tomorrow I’ll examine the opportunities the bankers ignored to avoid their current mess, how their mistakes could implicate other industries and what needs to be done to rectify the underlying causes of the banking problem.

This explanation of what caused the bankers to go wrong does not in any way excuse them but it helps Australians understand why it happened and the dangers of bringing together two toxic corporate cultures in a boom environment.

In years gone by, few developed countries had a better banking system than Australia and we were certainly well ahead of the US. Two decades ago, our top bankers were a conservative lot. They were not exciting but were good at their jobs. But the nature of their large corporate shareholders was changing rapidly. Along with many private investors, the new breed of institutional shareholders was looking for much greater reward from their bank shares. As Australian interest rates began to fall, the need for greater returns from banks began to increase.

The institutions and began putting intense pressure on bank boards to deliver greater earnings per share. Bank boards were sucked in and salary packages of senior bankers began to change so rewards were much more closely aligned to earnings per share and sometimes even the share price.

Not surprisingly, over time the motivation of the top management of most of the banks began to change and executives who delivered the earnings found themselves being promoted. Ian Narev was one such executive. But rather than blaming him personally, we need look to the forces that caused Narev-style CEOs to be catapulted to the top of most of the banks.

The banking pendulum had moved from them being customer-orientated organisations to ones where short-term shareholder returns dominated board and therefore executive strategies.

In the banking business, the way you increase short-term profit is to slash costs and/ or lend a lot more money, often by letting credit standards fall. Under these scenarios, the future could look after itself.

The pressure game played by the institutions became deadly.

If a bank did not perform its shares were slashed and sometimes the CEO’s job was in jeopardy. The media often adopted the institutional view of a company, multiplying its power. In this environment, making mistakes meant a possible job loss and that permeated down into middle managers who had mortgages and school fees to pay. But conceal your mistakes and you could keep your job and standard of living.

Australian’s bank regulators were slow to recognise that the culture of banks had totally changed from being customer focused and conservative into organisations where the shareholders, and risk taking had become paramount. And profit-driven bank executives often saw the regulators as a hazard to be overcome.

The institutions had “won” by changing the banking culture. But victory came at a huge, long-term cost, a cost that is now being suffered by bank shareholders.

During this cultural change process, the banks believed that if they entered the wealth management and life businesses there would be incredible synergies and big profits. In theory they were right, but they did not understand the culture of the industry they were getting into. Wealth management and financial planning is a relatively new industry and was established for the most part by insurance companies like AMP, Colonial and MLC plus.

The culture at these insurance companies was very different to the banks. The traditional skill of the banker was to assess credit. The traditional skill of the insurance company was simply hard selling on high commissions. In decades gone, by life insurance salesmen (and they were almost always male) were akin to today’s electricity sales people. The industry’s structure of incredibly high commission and long-term trail commissions was established in decades past, when life insurance policies were tax deductible.

When NAB bought MLC and CBA bought Colonial they did not fully appreciate that they were buying enterprises that were based on a totally different ways of doing business. To a lesser extent, the same thing happened when ANZ and Westpac entered the field. But AMP was the leader and NAB fought hard to buy it. Had NAB won control of AMP, the bank would have not survived.

AMP, MLC and Colonial were big drivers in the creation of the wealth management and financial planning industry. So not surprisingly, large parts of those businesses were driven by the hard selling and high commissions that were part of their traditional life insurance culture. The customers often found themselves ranking second to the selling organisation.

For the banks, this cocktail of a fixation on shareholders returns and the hard-sell culture of insurance businesses they’d acquired was to eventually prove a disaster.

Bank personnel were given bonuses to make them sell wealth and banking products. But they weren’t very good at it. The divisions were best illustrated by the way Sydney-based MLC was kept totally separate from NAB. Until relatively recently, incredible as it might seem, MLC continued to bank with its Sydney mate Westpac. NAB was seen as the owner not the operator.

Even so at NAB, the cultures mixed. Meanwhile, other banks were not as remote from their life and wealth businesses.

So the combination of profit maximisation and high pressure selling and high commissions was at the base of the banking mire. Ironically, some of the key institutions driving the profit maximisation culture were owned by the banks themselves.

But it might not have exploded if the success of the total banking-investment management operations had not created a high level of hubris in banking, at AMP and in other parts of the industry. These organisations took over the top places in the ASX 200. They seemed invincible because they had delivered what the institutions had wanted.

But when hubris is high, cracks are ignored.

The cracks appeared first in the company with the greatest hubris: Commonwealth Bank.

Journalist Adele Ferguson and others uncovered how high commissions and customer disregard had devastating effects on ordinary people. One of the first examples to surface was the so called Storm Financial scandal. At CBA, hubris had taken over and the messenger was bagged for revealing the facts. But eventually, the evidence became too great and the company was forced to set up a structure to look after damaged customers. But no one at CBA would admit error. So what should have been a huge rectification bill became relatively minor. The bank didn’t recognise that the fundamental flaw that had been exposed in its organisation was actually only the tip of the iceberg. It’s easy to blame Narev, but it was an industry wide cultural problem.

But there is one area where the CBA hubris was different to other banks. Commonwealth Bank had developed its own technology and believed its systems were superior to any other bank. Narev was warned by senior bankers from rivals that it was very dangerous to allow $20,000 to be deposited in the bank’s ATMs. But he was convinced by his technology people that this was under control and the warnings were ignored. The $700 million fine the bank must pay for anti-money laundering and counter-terrorism financing breaches tells us how that played out.

Meanwhile, ANZ appeared to get a whiff of problems in wealth management. It bought out its partner and addressed the at least some of the problems. Westpac had a much more limited exposure and its wealth management acquisition, BT, didn’t carry quite the same selling culture so its problems were not as deep.

AMP just kept doing what it always had done and didn’t recognise the difference between wealth management and financial planning and insurance selling and the need for proper disclosure.

Former CBA CEO Ian Narev Picture: Kym Smith

Eventually NAB decided that it shouldn’t leave MLC to operate completely separately. It sent one of its top bankers, Andrew Hagger, to go across to MLC to discover what was really happening there and try to sort out any problems. We don’t know the full Hagger story, but it seems he found a cesspool of problems but thought he could overcome them over time. That required buying time with the regulators. It was a wrong decision but it was part of the culture of concealment that has spread through the hubris-ridden industry.

In today’s environment the “right decision” would have been to face up to total problem and make the big outlays necessary to restore the fortunes of customers. But obsessed with short-term profit, bloodthirsty institutions would have slashed NAB’s share price, almost as a punishment. Many believe Hagger was the victim of the conflicting imperatives of maximising share prices and profits and the life office culture of high commission and pressure selling.

Sleepy regulators meanwhile, had not understood that the toxic culture mixed had been embraced by the banks and AMP.

And so the royal commission caught everyone out.

The sad thing is that the regulators are now doing what they should have done in the past. But they’re doing it with excess vigour, at a time when house prices are falling. There is now a great danger that as the regulators strive to show the community that they’ve learned their lessons, they will bring on a severe economic downturn and possibly a recession. Shareholders have already lost money as a result of the royal commission and if the regulators pursue the banks and AMP with the bloodthirsty zeal they showed at the FINSIA regulators lunch last week LINK weekend Australian ENDS LINK there is a lot more to be lost.

The really sad situation is that the entire Australian community may pay for the changes in bank culture, the insurance mess, and the hubris.

But the good news is that finally the Reserve Bank has taken a peep outside its heavily protected Martin Place bunker and discovered there is actually a credit squeeze taking place and the is now warning of over-regulation in banking.