Ken Henry’s brave new NAB board has little to recommend it

NAB chairman Ken Henry leaves the banking royal commission in Melbourne. Picture: AAP

The last fortnight of public hearings at the banking royal commission saw the grilling of several chief executives and chairmen of the big banks. It would be fair to say that the quality of the performance of these men — Catherine Livingstone was the only woman — was varied.

Some have been able to explain the rationale for their processes — the chief executive of the Macquarie Group — while others have been more apologetic about the misconduct and failures that have been features of their organisations’ recent history.

The most unforgettable was Ken Henry, National Australia Bank chairman and former Treasury secretary. He was in the dock for some time. It would be fair to say that he was verbose and ­ponderous.

When it came to the bank’s misconduct, he seemed to see the only alternative to trimming the bonuses paid to executives was to sack them all. No doubt, this came as something of a shock to the commissioner, counsel assisting and members of the audience.

Perhaps he was joking, but it’s hard to see that a royal commission public hearing is an appropriate venue for humorous or ironic remarks. Someone should have reminded Henry that he was not appearing before a Senate estimates committee, where the largely amateurish questions can be batted away, dismissed or taken on notice.

But Henry was keen to tell the commission he had given considerable thought to the functions of companies, the role of boards, and capitalism more generally. Whether entering into such a broad and contested set of issues was a good idea is open to debate

Henry doesn’t think companies should just serve their shareholders who have put up the capital so they can go about the business of selling goods and services. He thinks boards should be responsible to shareholders as well as other stakeholders and the community at large.

Now this is all very well, but the Corporations Act sets out the general duties of directors and officers and it is clear that directors of companies “must exercise their powers and discharge their duties in good faith in the best interests of the corporation”.

What this doesn’t mean in practice is that boards should ignore customers. In fact, it means quite the opposite: no customers, no company. It also doesn’t prevent the company from being an exemplary employer or treating its suppliers fairly.

And directors need not just think about the short-term interests of shareholders. There is nothing in the law that prevents a company from adopting a long-run strategy, for instance, although it is always best to communicate this thinking to shareholders.

Henry’s idea of putting customers first and the board having multiple responsibilities is muddle-headed, to say the least. The reality is that no company can serve its shareholders well unless it provides value-for-money goods and services.

Banks are an interesting case as financial intermediaries with many customers having long-term obligations to them — think the repayment of loans. This contrasts with the purchase of a water­melon from the fruit shop or a jacket from David Jones.

In other words, much of what banks do is not part of some spot market. Rather, it involves longstanding and complex interactions with customers, and responsibilities cut both ways. There must be remedies, for instance, if customers fail to meet their side of the bargain, although the terms of that bargain need to be made very clear. Good customer service on the part of banks doesn’t mean letting all delinquent borrowers default on their loans.

However, it’s easy to see why the banks have encountered such public opprobrium. Their wealth-management businesses are quite distinct from the core banking function of providing loans to businesses and individuals.

Let’s face it, wealth management is essentially a selling business in which financial products, often manufactured by or connected to the bank, are flogged to customers hopefully to meet their financial objectives. Apart from the large scope for conflicts of interest, in part arising from the payment of commissions, the ­selling of financial products and providing loans entail quite different skills.

It was always going to be an unhappy mix. The banks’ vertical integration model and the role of cross-selling to customers are now close to dead. Within a few years, there will be very little left of the arrangement within the big banks. All that retraining of NAB’s branch managers to be ­licensed financial planners will have been for nought.

So let’s come back to Henry’s alternative vision for companies and the role of boards. One obvious criticism is that by making boards accountable to multiple groups — and who is going to define community, by the way? — they will in fact become less accountable. If one group is disappointed, the directors can always argue that they have been serving another group well.

Where Henry’s vision of this alternative role for boards looks particularly weak is in relation to remuneration.

There is little doubt that the final report of the royal commission will highlight the centrality of defective remuneration incentives as a major source of the banks’ failings. With staff driven by the lure of maximising their short-term ­bonuses, it is hardly surprising that employees would try to game the system to ensure this outcome. Given the boards’ reluctance to cut bonuses even in the face of poor performance, it has been money for jam for many bank ­executives.

While Henry may be right to eliminate short-term bonuses from the remuneration structure of the NAB, his alternative plan has little to commend it. Executives will be rewarded though a “single variable reward based on performance”, with 40 per cent paid in cash and the remainder in deferred shares that can be clawed back.

The size of the reward pool for executives includes a “mix of customer, risk and financial metrics”. Regulatory compliance, customer outcomes and damage to a bank’s reputation also can been taken into account.

In all likelihood, Henry’s plan will be voted down by the shareholders, who regard the downgrading of the financial per­formance of the group as a retro­grade step. It’s one thing for the bank to improve customer service and to manage risk and reputation better (and bear in mind the subjective element to any assessment) — it’s another thing to largely ignore the shareholders.

The bottom line is that the role of company boards as set out in the Corporations Act remains fit for purpose. But directors who are confused about their roles and are seemingly asleep at the wheel some of the time should think about doing something else.