How setting the right rewards can help curb bad banking behaviour

The details of how fraud emerged within NAB’s introducer program offers insights into how bank culture can be fixed.

It is quite obvious that, regardless of what legislators and regulators impose or require of banks and other organisations, they have to have their own policies, processes, structures and systems for promoting good behaviours and detecting poor behaviours. (AFP PHOTO/PETER PARKS)

In light of the gobsmacking revelations of dishonesty and fraud within National Australia Bank’s "Introducer" program within the banking royal commission yesterday, a discussion paper on financial services culture issued by the UK’s Financial Conduct Authority this week provides a timely deep dive into issues of culture within the sector.

The paper is actually a collection of 28 essays from a range of contributors — bank executives and non-executives, academics and HR consultants.

A key conclusion is that regulation, while a necessary part of the prescription for managing cultures, isn’t by itself a solution to dealing with poor cultures and behaviours and can even be counter-productive if the minimum standards set by regulators become the maximum that an organisation and its people aspire to.

Another is that rewards — incentives — drive behaviours and can encourage good people to do bad things. They can also create a gulf, indeed a complete contradiction, between the goals set by the leadership of an organisation and what actually happens at the coalface.

There is a general acceptance within the paper that, regardless of the regulation or the best efforts of institutions to promote and manage strong and compliant cultures and the controls they put in place there will be instances of unethical or unlawful behaviour.

Indeed, in a quite pragmatic contribution, the Australian Securities and Investments Commission’s Andrew Fawcett said that ASIC recognises that "things will go wrong from time to time," saying that it is a natural part of doing business.

His paper was focused on breach reporting, arguing that how regulated firms met their reporting obligations was an indicator of how effective they are at identifying and responding to problems when they arise.

A sound breach reporting culture, he wrote, was likely to demonstrate transparency, effective communication and escalation, accountability, responsiveness — changes to processes and systems — and customer remediation. Breaches and their timely reporting were, in effect, an opportunity to learn and change, as well as to compensate for the damage done to customers.

While most of the individual papers were as much about the values institutions should hold and communicate to their employees rather than practical methods of implementing and protecting them, there was quite a significant discussion about incentives.

In the NAB introducer program, where external parties were paid large commissions for referring customers to the bank, the incentives led to faked documents, unsuitable loans and even bank staff being bribed.

Incentives or other forms of reward — promotion, for instance — drive behaviours and send signals about an organisation’s priorities.

Poorly designed rewards, particularly those based on crude metrics like sales targets, can make the unacceptable behaviour appear condoned and encouraged by the organisation and, as one of the contributors noted in a slightly different context, lead to a disconnect between the way employees see themselves and their ethics and their actual behaviour.

There was one very practical approach outlined by TSB Bank chief executive Paul Pester and his HR director, Rachel Lock. TSB, now owned by a Spanish banking conglomerate, was forcibly divested by Lloyds Bank in 2013.

TSB has no sales targets or sales-linked rewards and doesn’t allow access to comparative sales data at a branch or area director level.

It rewards staff purely on the level of service given to customers, with all staff participating in a profit sharing scheme, worth about 10 per cent of their salaries, again tied only to customer satisfaction levels.

Staff assessment revolves around skills, attitude and behaviour rather than by any of their outputs.

For most commercial organisations there are obvious reasons to measure their success, and that of their individual employees, with hard metrics. Companies have to grow their sales and earnings to deliver on shareholder expectations and executives’ own incentives and they have to do so in the short term.

There’s a lot of pressure on their people to deliver that near-term growth, particularly in competitive markets. While there are constant references to the concentration of the Australian banking market and the dominance of the "Big Four" the market is very competitive because the majors are large by international standards and the economy relatively small.

TSB’s philosophy is to focus on customer demands rather than its own capacity to supply — not trying to sell customers as many products as possible, regardless of whether the customer needs them or if the products are suitable for them.

Many, if not most, of the "conduct issues" in this market relate aggressive mis-selling and the prioritisation of banks and individuals’ financial outcomes over the best outcome for customers.

A former senior Investec executive, Dr Allen Zimbler, referred to the "iceberg" metaphor, a way of describing the more overt and objective elements of an organisation — systems, structures, strategies, financial controls and reporting mechanisms, technology marketing and services — that are definable and measurable and perhaps controllable. Those are the bits of the organisation that are "above the water."

The bits below are the perceptions, emotions, attitudes, value systems, interpersonal dynamics, and agendas of the people within the organisation. They are difficult to see let alone measure or control but, as Zimbler wrote — and NAB and its peers could testify — the reputations of longstanding institutions can be damaged or even destroyed by the actions of individuals or groups of individuals.

It is quite obvious that, regardless of what legislators and regulators impose or require of banks and other organisations, they have to have their own policies, processes, structures and systems for promoting good behaviours and detecting poor behaviours.

The legislators and regulators increasingly hold senior executives and boards accountable for ethical miss-steps or miscalculations by staff in the middle or lower rungs of their organisation that they — the executives and directors — will only become aware of after the event.

There will be innocent victims at the most senior levels of the banks unless they fundamentally change the way their organisations operate. Some of those changes, actually many of them, have already been implemented but it’s the cultural piece that is the most difficult to achieve.

Technology might be part of the answer but the larger part is in having good people at every level behaving completely in tune with their individual ethics, being rewarded for doing so, and being encouraged to identify and report breaches of ethical standards within a structure that enables the information to travel up through the organisation speedily. Boards and C-suiters can’t continuously monitor individuals in branches but their co-workers can.

Culture and the benefits it may or may not generate for organisations can’t be measured with any precision and in any event will always be evolving as the environment around the organisations changes.

Significant breaches of ethical standards, however, have a heavy cost, as the banks and insurers, including some smaller organisations, could testify and are now experiencing under the glare of the spotlight the royal commission is shining on the misbehaviours of their people.