Should Wells Fargo execs responsible for bilking customers be forced to return their pay?

From The Conversation.

Having spent five years supervising large financial institutions on Wall Street, I am rarely surprised by the latest news of banks behaving badly.

But even the most hardened cynics, such as myself, were taken aback by the recent announcement that Wells Fargo was being fined US$185 million for fraudulent sales practices that included opening over two million fake deposit and credit card accounts without informing its customers.

Adding to my shock was the revelation that the firm fired 5,300 employees over the course of five years for engaging in this behavior, clearly evidence that this was more than just a few bad apples.


The financial crisis and its aftermath have taught us that it is unlikely any of Wells Fargo’s senior executives will face criminal charges. The reasons for this are numerous, but essentially prosecutors have a hard time identifying criminal intent within the upper ranks of bank management.

At the very least, don’t Wells Fargo’s customers have a reasonable expectation that executives who profited off their misfortune be required to return some of their ill-gotten gains?

The good news is that in April, U.S. regulators released a proposed rule requiring financial institutions to do just that. Unfortunately for fraud victims seeking a pound of flesh from Wells Fargo executives, the rule is not scheduled to be finalized until November, although the bank claims to be in adherence with the proposal’s main provisions.

Nonetheless, I thought it would be interesting to examine the text of the proposed incentive-based compensation rule through the lens of the Wells Fargo situation to try and understand its potential implications.

Cultural failure

On the surface Wells Fargo’s fraud appears to be an all-too-familiar case of cultural failure within a big financial institution. Apparently CEO John Stumpf disagrees.

In a Wall Street Journal interview shortly after the story broke, Stumpf refused to admit any institutional failure at the bank, claiming the behavior of the terminated employees “in no way reflects our culture nor reflects the great work the other vast majority of the people do.”

If Stumpf thinks that over 5,000 unethical people just so happened to find their way to Wells Fargo, he may want to rethink the company’s hiring practices.

Thus far the company has declined to say how many branch, regional or corporate managers were among those let go. The initial readout seems to be that most of those dismissed were low-level branch employees – hardly your typical Wall Street villains.

The spotlight has now turned to senior managers, and what they did or did not know. It is shining brightest on Carrie Tolstedt, who has run Wells Fargo’s community banking division since 2008 and is set to retire at the end of the year. Tolstedt appears to have profited handsomely from the sales practices in question.

A 2015 company filing indicates that part of Tolstedt’s 2014 inventive compensation award of roughly $8 million stems from:

“success in furthering the company’s objectives of cross-selling products from other business lines to customers, reinforcing a strong risk culture and continuing to strengthen risk management practices in our businesses.”

It now appears that cross-selling products and strengthening risk management were competing objectives.

Clawing back compensation

As noted earlier, Wells Fargo says it’s already in compliance with the main provisions of the proposed rule.

Specifically, in a recent filing, the bank claims:

“Wells Fargo has strong recoupment and clawback policies in place designed so that incentive compensation awards to our named executives encourage the creation of long-term, sustainable performance, while at the same time discourage our executives from taking imprudent or excessive risks that would adversely impact the Company.”

This means the bank can cancel, or claw back, any incentive-based executive compensation, such as deferred bonuses or stock options, from executives who engaged in misconduct or who received such compensation based upon materially inaccurate information, “whether or not the executive was responsible.”

Thus far the company has given no indication it intends to claw back any of Tolstedt’s compensation, although pressure from the public and regulators may soon change this.

The proposed rule

So let’s imagine the new incentive-based compensation rule was already in place and consider how it would work.

The rule’s most stringent requirements apply to “level 1” financial institutions like Wells Fargo with over $250 billion in consolidated assets. Its provisions cover all employees who receive incentive-based compensation, with enhanced requirements for individuals referred to as senior executive officers and significant risk takers.

As head of a major business line, Tolstedt would qualify as a senior executive officer, and her compensation would be subject to:

  • higher minimum deferral requirements – the percentage of incentive-based compensation that cannot be cashed in until the passing of a specific amount of time (meant to encourage long-term thinking);
  • forfeiture of “unvested” compensation (that is, compensation that has been awarded but has yet to be fully transferred to the employee); and
  • clawbacks for so-called vested compensation that has already been transferred to the employee.

Since Tolstedt is retiring soon, the rule’s minimum deferral requirements are less relevant here. But for past performance periods, unvested compensation could be forfeited and vested pay could be clawed back.

Even if one generously assumes Tolstedt was unaware of the fraud taking place, she was still likely responsible for setting the sales goals and compensation structure that incentivized so many employees to defraud customers. Indeed the firm’s own filings with the SEC seem to confirm this. Using these assumptions and applying the text of the proposed rule, it is clear that nearly all of her unvested incentive-based compensation could be forfeited, and her vested compensation could also be at risk of being clawed back.

The proposed rule identifies several types of events that would require covered firms to initiate a forfeiture review. Those most relevant in the Wells Fargo situation include:

  • inappropriate risk-taking, regardless of the impact on financial performance;
  • material failures of risk management or control; or
  • noncompliance with statutory, regulatory or supervisory standards that results in enforcement or legal action against the covered institution brought by a federal or state regulator or agency.

The proposal leaves it to the firm to determine the amount to be forfeited, provided it can support its decisions.

The standards that trigger a review of whether vested compensation should be clawed back are higher (though firms can loosen them). Such situations include a senior executive officer engaging in misconduct that results in significant financial or reputational harm to the institution, fraud or intentional misrepresentation of information used to determine the employee’s incentive-based compensation.

Based on the facts as we currently know them, it would be difficult to prove Tolstedt met the rule’s clawback criteria, since it’s not known if she actually engaged in the fraud herself. If she had, all of the incentive-based compensation that had vested since the fraudulent activity began would be subject to being clawed back.

‘Standard-bearer of our culture’

Assuming the rule was currently in effect, and Wells Fargo was adhering to it, how much would Tolstedt stand to lose?

This is almost impossible to determine given that she has worked at the firm for 27 years, we don’t know how long the fraudulent activity went on for, publicly available information on her compensation is limited and the rule leaves it up to the firm to determine the dollar amount that is forfeited and/or clawed back.

The Consumer Financial Protection Bureau’s Wells Fargo ruling indicates the “relevant period” lasted from Jan. 1, 2011, to Sept. 8, 2016. Over that time frame, Tolstedt received at least $36 million in incentive-based compensation, compared with $8.5 million in base salary.

Under the terms of the proposed rule, Wells Fargo would be able to get back at least half of the $36 million. If Tolstedt was found to have known about the fraud taking place within her division, they could likely get it all back.

When the firm announced in July that Tolstedt would be retiring at the end of the year, Stumpf referred to her as a “standard-bearer of our culture” and “a champion for our customers.” At the time, the firm was winding down its five-year employee purge.

Knowing what we know now, Stumpf could have easily fired her and attempted to claw back a significant amount of her pay. Instead he chose loyalty to a long-time employee over loyalty to his customers. Next time that choice may be off the table.

Author: Lee Reiners, Director of Global Financial Markets Center, Duke University

Deutsche Bank Looks to Settle US Mortgage Legal Exposure at a Reasonable Cost – Moody’s

According to Moody’s on 15 September, Deutsche Bank AG announced in a filing that it has commenced negotiations with the US Department of Justice (DoJ) aiming to settle civil claims in connection with the bank’s underwriting and issuance of residential mortgage-backed securities (RMBS) and related securitization activities between 2005 and 2007. Eliminating the claims’ litigation tail risk at a manageable cost would be credit positive for Deutsche Bank, but negotiations have just begun and the final cost of settlements of complex capital markets litigation remains very difficult to predict.

At the end of the second quarter of 2016, Deutsche Bank had €5.5 billion of litigation reserves, for a variety of legal matters, but the bank has not disclosed the size of reserves for any specific action. For the analysis below, we have assumed that at least half of the litigation reserve could be made available for a possible DOJ settlement. If Deutsche Bank can eliminate this tail risk and settle within or near the assumed reserve of €2.75 billion (or $3.1 billion), it would be positive for bondholders.

Deutsche Bank has indicated its willingness to consider settlements at a cost broadly in line with peers’ prior settlements. However, as Exhibit 1 indicates, peers’ settlements have varied widely, ranging from $1.7 million to $8.9 million per basis point of RMBS league table share. Based on Deutsche Bank’s 6.4% market share, a settlement in the low end ($1.7 million per basis point) or even at the mid-point ($3.6 million per basis point) of the settlement range would be well covered by our assumed DOJ settlement reserve. However, a DB settlement at the high end of announced peer settlements ($8.9 million per basis point) would total $5.7 billion. A settlement of $5.7 billion would require an addition to our assumed DOJ settlement reserve of €2.4 billion, which would dent 2016 profitability (pretax earnings for first-half 2016 totaled €1 billion), a credit negative. Basing litigation exposure solely on market share is a crude approximation, but it helps dimension the adequacy of reserves and potential income statement effect.


The commencement of these negotiations is not surprising since Deutsche Bank management set a strategic objective to resolve crisis-related litigation and remove uncertainty hanging over the bank. As the complex negotiations proceed, we also expect that management have strong incentives to resist a quick settlement with the DOJ that is more expensive than the prior settlements of peers. These incentives include preserving flexibility with respect to paying coupons on its additional Tier 1 (AT1) securities. Even a settlement requiring an additional $2.4 billion of reserve should still leave Deutsche Bank with sufficient flexibility to pay its 2017 AT1 coupons. We expect this flexibility to increase given the EBA’s announced intention to bifurcate Pillar 2 capital requirements into required and guidance components, with only the required component factoring into the calculation of the Maximum Distributable Amount for AT1 coupon payments.

Finally, Deutsche bank’s current Baa2 rating and stable outlook already incorporates the possibility of a modest loss (and substantial litigation costs) in 2016 and the potential for limited profitability in 2017.

“Cosy” Terms of Reference For Big Four Banks Hearings

The Government has released the terms of reference which will govern the appearance of the big four banks before the Standing Committee On Economics.


The Treasurer has asked the committee to hold public hearings at least annually with the four major banks focusing on:

  • domestic and international financial market developments as they relate to the Australian banking sector and how these are affecting Australia
  • developments in prudential regulation, including capital requirements, and how these are affecting the policies of Australian banks
  • the costs of funds, impacts on margins and the basis for bank pricing decisions, and
  • how  individual banks and the banking industry as a whole  are responding to issues previously raised in Parliamentary and other inquiries, including through the Australian Bankers’ Association’s April 2016 six point plan to enhance consumer protections  and  in response to Government reforms and actions by regulators.

Given the aim of the appearances was to counter calls for a Royal Commission on the finance sector, they do appear very gentle. Whilst there are some culture-related issues being handled by the ABA’s internal processes, sharper question about remuneration practices, complaints as well as structural and organisational issues should be on the agenda, if the sessions are to have teeth. For example:

  • How does the vertically integrated business structures, across banking, wealth and insurance, and from advice through to sales and service (both via internal and third party channels) impact consumer outcomes?
  • Do commission arrangements degrade the quality of advice, product fit and price consumers receive?
  • What are the root causes of the recent raft of poor practice and complaints. What is being done to address them?

The committee does include cross-party representation, but with a noticeable bias towards the current governing parties!

The voice of smaller competitors and consumers of bank services will not be heard though this process.

It all feels rather cosy!

ABC 7:30 Does Lenders Mortgage Insurance

7:30 did a segment tonight on Lenders Mortgage Insurance (LMI). As we discussed in an earlier post there are a number of issues which make LMI a complex area.  The segment includes comments from DFA.

Households wising to borrow at an LVR above 80% will be required to pay a significant insurance premium to get a mortgage – Lenders Mortgage Insurance. This extra cost may be bundled into their overall mortgage, or will be a large additional cost.

Many households are not clear on what is truly covered by the LMI in case of default. Whilst LMI may protect the bank, households are not necessarily protected.

In addition, the costs of LMI are not necessary transferable, and there are some industry concentration risks caused by the limited market of providers, over and above the captive insurers within the banks.



ASIC releases guidance on review and remediation

ASIC has released guidance on review and remediation conducted by Australian financial services (AFS) licensees providing personal advice to retail clients.


This follows Consultation Paper 247 Client review and remediation programs and update to record-keeping requirements (CP 247), issued in December 2015 (refer: 15-388MR).

The guidance reflects work done with industry over the past several years where ASIC has worked with advice licensees with large remediation programs to shape the scope and nature of remediation arising from systemic advice issues.

The key principles set out in the guidance are:

  • review and remediation is likely to be appropriate where a systemic issue has occurred that may have caused loss or detriment to clients
  • the scope of review and remediation should ensure it covers the right advisers, the right clients and the right timeframe
  • the process of review and remediation should be comprehensive, timely, fair, and transparent. There should be clearly defined principles to guide the process and an appropriate governance structure
  • effective, timely and targeted communication is key to ensuring that clients understand the review and remediation and how it will affect them; and
  • clients should have access to an EDR scheme if they are not satisfied with the remediation decision made.

‘ASIC wants to ensure that advice licensees proactively address any systemic problems caused by their conduct and, where necessary, put processes in place to remediate their clients for loss suffered in a way that is timely, fair and transparent,’ ASIC Deputy Chairman Peter Kell said.

‘Advice firms that take effective and timely steps to fix problems if something goes wrong will be much better placed to retain the trust and confidence of their clients,’ said Mr Kell

In the 2015-16 financial year, ASIC secured over $200 million in compensation and remediation for financial consumers and investors across the areas it regulates.

While the guidance is directed at licensees who provide personal advice to retail clients, review and remediation takes place in many other sectors of the financial services industry. The principles set out in the guidance should be applied to other review and remediation where relevant.

ASIC will shortly release an amendment to Class Order [CO 14/923] Record-keeping obligations for Australian financial services licensees when giving personal advice together with a report summarising the key feedback ASIC received in response to CP 247, and our response to that feedback.

Wells Fargo Bank fined $100 million for widespread unlawful sales practices

According to the US Consumer Finance Protection Bureau (CEPB), hundreds of thousands of accounts secretly created by Wells Fargo Bank employees has led to an historic $100 million fine.


Today we fined Wells Fargo Bank $100 million for widespread unlawful sales practices. The Bank’s employees secretly opened accounts and shifted funds from consumers’ existing accounts into these new accounts without their knowledge or permission to do so, often racking up fees or other charges.

The Bank had compensation programs for its employees that encouraged them to sign up existing clients for deposit accounts, credit cards, debit cards, and online banking. According to today’s enforcement action, thousands of Wells Fargo employees illegally enrolled consumers in these products and services without their knowledge or consent in order to obtain financial compensation for meeting sales targets.

Bank employees temporarily funded newly-opened accounts by transferring funds from consumers’ existing accounts in order to obtain financial compensation for meeting sales targets. These illegal sales practices date back at least five years and include using consumer names and personal information to create hundreds of thousands of unauthorized deposit and credit card accounts.

The law prohibits these types of unfair and abusive practices.

Violations covered in today’s CFPB order include:

  • Opening deposit accounts and transferring funds without authorization, sometimes resulting in insufficient funds fees.
  • Applying for credit-card accounts without consumers’ knowledge or consent, leading to annual fees, as well as associated finance or interest charges and other late fees for some consumers.
  • Issuing and activating debit cards, going so far as to create PINs, without consent.
  • Creating phony email addresses to enroll consumers in online-banking services.

 Enforcement Action

Under the Dodd-Frank Wall Street Reform and Consumer Protection Act, we have the authority to take action against institutions that violate consumer financial laws. Today’s order goes back to Jan. 1, 2011. Among the things the CFPB’s order requires of Wells Fargo:

  • Pay full refunds to consumers.
  • Ensure proper sales practices.
  • Pay a $100 million fine.

Today’s penalty is the largest we have imposed. Other offices or agencies are also taking actions requiring Wells Fargo to pay an additional $85 million in penalties.

In a discussion on the Knoweldge@Wharton site, they highlight this may not be a one off. The “cross sell” business model underpinning banking is to blame.

More Banks May Be Involved: “It’s not just Wells Fargo,” says Cook. “Fees are a critical part of the profit model for banks in the U.S.” Conti-Brown agrees, and says the practice of cross-selling brings in the fee income that banks badly want. “Cross-selling is one of the reasons Wells Fargo is said to be so successful,” he says of the bank, which along with its parent of the same name, controls some $1.9 trillion in assets. “The [bank’s] incentive structure is flawed,” he says, explaining that deviant practices could occur if top management ties employee rewards to signing up existing customers to more products and services.

CBA pays $180,000 in penalties and will write off $2.5 million in loan balances

ASIC says Commonwealth Bank of Australia (CBA) has paid four infringement notices totalling $180,000 in relation to breaches of responsible lending laws when providing personal overdraft facilities.

CBA reported this matter to ASIC following an ASIC surveillance. CBA conducted an internal review which identified a programming error in the automated serviceability calculator used to assess certain applications for personal overdrafts.


As a result of the error, between July 2011 and September 2015, CBA failed to take into consideration the declared housing and living expenses of some consumers.

Instead, CBA’s serviceability calculator substituted $0 housing expenses, and living expenses based on a benchmark which in some instances was substantially less than the living expenses declared by the consumer. As a result, this led to an over-estimation of the consumer’s capacity to service the overdraft facility.

CBA informed ASIC that between July 2011 and September 2015, as a result of the error, CBA approved:

  • 9,577 consumers for overdrafts which would have otherwise been declined; and
  • 1,152 consumers for higher overdraft limits than would have otherwise been provided.

Some consumers were approved for a personal overdraft, or an increased limit on their personal overdraft, even though their declared expenses were greater than their declared income.

ASIC was concerned that this conduct breached responsible lending laws and that affected consumers would have been unable to comply, or could only comply with substantial hardship, with their obligation to repay their personal overdraft on demand.

CBA has informed ASIC that it will write off a total of approximately $2.5 million in personal overdraft balances.

ASIC Deputy Chairman Peter Kell said, ‘Credit licensees should continuously monitor their internal processes to ensure compliance with the law. This is especially the case with automated decision-making systems where ongoing monitoring is needed to ensure that information is correctly inputted into systems.’


The responsible lending obligations that prohibit lenders from entering into credit contracts which are unsuitable for the consumer are found in the National Consumer Credit Protection Act 2009 (Cth). The laws aim to ensure that credit contracts are not unsuitable for consumers (see s133(1)), and consumers are likely able to afford the credit contract (see s133(2)).

ASIC issued four infringement notices in August 2016 totalling $180,000 for the breaches outlined above.

CBA self-reported the breaches to ASIC, and has co-operated with ASIC’s investigation.

The payment of an infringement notice is not an admission of guilt in respect of the alleged contravention. ASIC can issue an infringement notice where it has reasonable grounds to believe a person has committed particular contraventions of the National Credit Act.

ASIC on mortgage brokers’ interest only loans

ASIC says the volume of interest only loan approvals rose significantly in the June 2016 quarter. But Australia’s home loans industry has improved its performance over the past year, adopting better ‘responsible lending’ practices, though there is still room for improvement.


ASIC has released its report (REP 493) ‘Review of interest-only home loans: Mortgage brokers’ inquiries into consumers’ requirements and objectives’ on the responsible lending practices of 11 large mortgage brokers with a particular focus on how they inquire into and record consumers’ requirements and objectives.

It also examined how the changes implemented by lenders in response to the findings from ASIC’s report into interest-only home loans from 12 months ago last year (refer: Report 445) have flowed through to mortgage brokers.

Since the release of Report 445 in August 2015,

  • the percentage of new home loans approved by lenders which are interest-only has decreased by 12%; and
  • the amount that can be borrowed by an individual consumer through an interest-only home loan has decreased, as lenders have adjusted their assessment of consumers’ ability to repay, in line with ASIC’s recommendation in Report 445.

Information provided by the mortgage brokers showed that for the six months from July 2015 to December 2015,

  • the number of new interest-only home loans fell by 16.3%, with total value of these loans reducing by 15.6%; and
  • the percentage of interest-only loans with a term greater than five years reduced by more than half, from 11.2% to 5.1%.

Almost 80% of applications reviewed included a statement summarising how the interest-only feature specifically met the consumer’s requirements and objectives. This compared favourably with Report 445’s finding that more than 30% of applications reviewed showed no evidence the lender had considered whether the interest-only loan met the consumer’s requirements.

‘It is vital that mortgage brokers understand consumers’ requirements and objectives to ensure they are not placed in unsuitable credit contracts,’ said ASIC deputy chairman Peter Kell.

‘ASIC is pleased that our concerns about interest-only loans and responsible lending are being acted on by the home lending industry, but there is still room for improvement.’

ASIC identified practices that place brokers at increased risk of non-compliance with their responsible lending obligations, and identified opportunities for brokers to improve their practices. Key compliance risks identified included:

  • Policies and procedures—Mortgage broker policies and procedures provided only general information, rather than tailored information on specific products and loan features that may impose increased financial obligations or restrict repayment flexibility (such as interest-only home loans);
  • Recording of inquiries—Record keeping was inconsistent and in some cases records were fragmented and incomplete;
  • Explaining the loan choice—More than 20% of applications reviewed did not include a statement explaining how the interest-only feature of the loan specifically met the consumer’s underlying requirements and objectives. The level of detail in these statements varied considerably and in some cases, where an interest-only loan was specifically sought by a consumer (including where this option was recommended by a third party, such as an accountant), the reason for this was not clear;
  • Consumer understanding of risks and costs—In some cases, where the potential benefit of the interest-only loan depended on the consumer taking specific action (for example, allocating additional funds to higher interest debt), it was unclear whether the consumer understood the potential risks/additional costs if the specific action was not taken.

The report details steps that mortgage brokers should take to improve their current practices, including:

  • Ensuring they understand the consumer’s underlying objectives for requesting specific loan products and features;
  • Recording concise summaries of consumers’ requirements and objectives and the reason why a particular product, features and lender was chosen;
  • Providing a statement summarising the broker’s understanding of the consumer’s requirements and objectives, which could also include the reason a particular loan is suggested, for the consumer to confirm before obtaining a loan.
  • Where the potential benefits of a loan feature might require the consumer to undertake specific behaviour, ensuring consumers were aware of the action they needed to take to obtain the potential benefit, as well as the potential costs should this action not be taken.

Westpac refunds $9.2 million after failing to waive bank account fees for eligible customers

ASIC says Westpac Banking Corporation (Westpac) has refunded approximately $9.2 million to 161,414 customers after it failed to waive fees on Westpac and St. George branded savings and transaction accounts over six years.


For customers aged under 21 years, Westpac previously relied on staff to manually apply the following fee waiver benefits:

  • a monthly service fee waiver for customers with a Westpac Choice transaction account; and
  • a withdrawal fee waiver for customers with a Westpac Reward Saver account.

However, between May 2007 and April 2013, 133,045 Westpac Choice and Westpac Reward Saver accounts were opened for some eligible customers without the relevant fee waivers being applied.

Westpac also discovered that there were 28,369 customers under the age of 18 who were eligible for a St. George Complete Freedom Student transaction account (which has no monthly service fee), but instead held a standard St. George transaction account which charged a monthly fee.

Westpac reported this matter to ASIC under its breach reporting obligations in the Corporations Act. ASIC acknowledges the cooperative approach taken by Westpac in resolving this matter.

Compensation and systems changes

Westpac has now provided refunds to affected customers. The refund payments included an additional amount reflecting interest.

In addition to compensating customers, Westpac is enhancing the account opening process for these Westpac and St. George products to ensure all new eligible customers receive the relevant fee waivers. This includes automated application of the relevant fee waivers based on the customer’s date of birth submitted during the application process. Westpac also monitors this activity to ensure the correct treatment of eligible accounts.

ASIC Deputy Chairman Peter Kell said, ‘Financial institutions that offer products with benefits such as fee waivers must have effective and robust systems in place to deliver the promised benefits to consumers.’

‘Businesses that rely on manual processes to apply waivers, discounts and other benefits should carefully consider how they manage the risks of processes not being followed, including having appropriate controls and procedures in place.’

A history of failed reform: why Australia needs a banking royal commission

From The Conversation.

The move for an inquiry into how banks treat small business customers should not overshadow the ongoing call for a broader royal commission on banks.

Several financial inquries (outlined below) have failed to tackle the growing concentration in the Australian finance sector, or the need to separate general banking from investment banking as the reform process in the United States, UK and Europe is contemplating.

Calls for a royal commission are also underpinned by ongoing reports of misconduct within the banks, summarised in a timeline of bad behaviour below.

Every other major industrial country is at an advanced stage in bank reform, and Australia would be isolated if it did not engage in a similar substantial and structural reform process.

Former Commonwealth Bank chief and Financial Services Inquiry Chair David Murray released the final report of the inquiry in December 2014. Britta Campion/AAP

Financial reform in Australia

1997 Wallis Inquiry

This inquiry has been associated with the “four pillars” policy towards bank mergers (though the inquiry itself did not propose this), and the opposition to any merger between ANZ, CBA, NAB and Westpac. The unwritten policy originated in Paul Keating’s reservations on concentration in the industry. It also led to the CLERP financial reforms announced on fund raising, disclosure, financial reporting and takeovers.

2009 Future of Financial Advice Inquiry

This inquiry stemmed from industry failures, such as Storm Financial and Opes Prime, and explored the role of financial advisers and the general regulatory environment for these products and services. It resulted in the Corporations Amendment (Future of Financial Advice) Act 2012 by the Labor government to tackle conflicts of interest within the financial planning industry. This was subsequently amended by the Liberal government in the Corporations Amendment (Financial Advice Measures) Act March 2016 which softened some of the reforms.

2012 Cooper Inquiry

This was a review into the governance, efficiency, structure and operation of Australia’s superannuation system. It examined measures to remove unnecessary costs and better safeguard retirement savings, claimed fees in superannuation were too high, and that choice of fund in superannuation had failed to deliver a competitive market that reduced costs.

2014 Parliamentary Joint Committee on Corporations and Financial Services Inquiry

This inquiry included proposals to lift the professional, ethical and education standards in the financial services industry. It aimed to clarify who could provide financial advice and to improve the qualifications and competence of financial advisers; including enhancing professional standards and ethics.

2015 Murray Inquiry

This inquiry was intended to provide “a ‘blueprint’ for the financial system over the next decade,” but fell somewhat short of this in not critically addressing the concentration or restructuring of the main banks. While acknowledging the high concentration and vertical integration of Australia’s banking industry the inquiry’s approach to encouraging competition was to seek to remove impediments to its development. The inquiry aimed to increase the resilience to failure with high bank capital ratios, and to reduce the costs of failure, including by ensuring authorised deposit-taking institutions maintained sufficient loss absorbing and recapitalisation capacity to allow effective resolution with limited risk to taxpayer funds.

Demonstraters throw their support behind US Senator Elizabeth Warren’s proposal to reform the Glass Steagall Act. Shannon Stapleton/Reuters

In contrast to the limitations of the Australian reform process, more ambitious reform of the banking sector is being actively considered in the rest of the advanced economies. This is because of widespread international concerns regarding bank monitoring and standards, and the continuing threat of systemic risk and failure.

The objective is to create more effective competition, greater choice, improved governance, more balanced incentives, and responsible behaviour and performance. Central to international reform proposals is the intention of:

  • shielding commercial banks from losses incurred by speculative investment banking
  • preventing the use of public subsidies (eg central bank lending facilities and deposit guarantee schemes) from supporting risk taking
  • reducing the complexity and scale of banking organisations
  • making banks easier to manage and more transparent
  • preventing aggressive investment bank risk cultures from infecting traditional banking;
  • reducing the scope for conflicts of interest within banks
  • reducing the risk of regulatory capture and taxpayers exposure to bank losses.

Among the ongoing international initiatives to reform the banks are the UK Banking Reform Act, which includes ring fencing retail utility banking from investment banking, due for implementation in 2019.

In the US, the 21st Century Glass Steagall Act, proposed by Elizabeth Warren and supported by Democratic nominee Hillary Clinton, involves separating traditional banks that offer savings and checking accounts from riskier financial services such as investment banking and insurance.

In Europe, the Liikanen Plan, announced in 2012, proposes investment banking activities of universal banks be placed in separate entities from the rest of the group. This has already been taken up widely throughout the European banking sector.

A licence to operate?

The banks have experienced continuous systemic risk (partly of their own making), erosion of their integrity, and a loss of public trust.

The Australian banks are on notice that they need to renew their licence to operate, to reconnect with their sense of duty and the Australian people, and to reconfirm their responsibilities to the Australian economy. This will occur, even if it takes a royal commission to achieve it.

A timeline of banks behaving badly

January 2004: NAB foreign currency options trading

NAB announces losses of A$360 million due to unauthorised foreign currency trading activities by four employees who concealed the losses. Bank risk policies and trading desk supervision prove ineffective. NAB sacks or forces the resignation of eight senior staff, disciplines or moves 17 others and restructures its board of directors. Four traders, including the head of the foreign currency options desk, are subsequently prosecuted and jailed.

2008: global financial crisis takes down Opes Prime, Storm Financial, Allco and Babcock and Brown

The market capitalisation of the stock markets of the world peaks at US$62 trillion at the end of 2007. By October 2008 the market is in free fall, having lost US$33 trillion dollars, over half of its value in 12 months of unrelenting financial and corporate failure. Originating in the toxic sub-prime securities of the New York investment banks, the financial crisis threatens to engulf the economies of the world.

The mythology today is that Australia miraculously escaped the global financial crisis due to the resilience of its regulatory system and the governance and risk management of its banks. The reality is that more than a dozen significant Australian companies went under during the crises (amounting to losses in excess of $60 billion in total). In almost every case at least one of the big four banks were involved in supporting the business models and extending credit to very doubtful enterprises.

July 2012: HSBC money laundering

A US Senate Inquiry discovers that HSBC allowed Latin American drug cartels to launder hundreds of millions of ill-gotten dollars through its US operations, rendering the dirty money usable. The HSBC Swiss private banking arm profited from doing business with arms dealers and bag men for third world dictators and other criminals.

HSBC agrees to pay a fine in excess of US$2 billion to settle US civil and criminal actions. In 2016 it is revealed that UK Chancellor George Osborne intervened to prevent criminal charges against HSBC as this might have undermined financial markets.

2013: Libor rigging

Libor is the international vehicle for settling inter-bank interest rates, and covers markets worth US$350 trillion.

In 2012 it’s revealed that wholesale fraudulent manipulation of the rates has been occurring for years, and throughout the reform process following the global financial crisis. The crisis engulfs many international banks including Barclays, Citigroup, Deutsche Bank and JP Morgan. The irony of the scandal is that Libor was intended as a measure of the state of health of the banking system.

The US Commodity Futures Trading Commission and US Department of Justice impose fines totalling hundreds of millions of dollars on the international banks. In Australia ASIC investigates the role of ANZ, BNP, UBS, and RBS and imposes fines. In 2014 the administration of Libor is transferred to the Euronext NYSE.

2014: Commonwealth Bank financial planning scandal

An ABC Four Corners report reveals CBA customers have lost hundreds of millions of dollars after the bank’s financial advisers recommend speculative investments.

The report describes the sales-driven culture inside the Commonwealth Bank’s financial planning division, with a focus on profit at all cost and a culture that has been built on commissions. The bank is found to have misled potentially thousands of clients.

The bank sets up an internal inquiry and compensation (though is subsequently accused of dragging its feet on compensation). A Senate inquiry into the performance of ASIC during the affair recommends establishing a Royal Commission to examine the banks.

May 2015: Forex manipulation

Following the Libor scandal, it is discovered that traders have been deliberately orchestrating trades in the $US5.3 trillion-per-day global foreign exchange market to their own advantage.

“They acted as partners – rather than competitors – in an effort to push the exchange rate in directions favourable to their banks but detrimental to many others,” says US Attorney-General Loretta Lynch. “And their actions inflated the banks’ profits while harming countless consumers, investors and institutions around the globe.”

US and British regulators fine Barclays, Citigroup, JP Morgan, RBS, UBS, and Bank of America more than US$6 billion in recognition of the scale and duration of the fraud.

March 2016: ASIC targets ANZ for rigging the bank bill swap rate (BBSW)

ASIC commences legal proceedings against ANZ for unconscionable conduct and market manipulation in relation to the bank’s involvement in setting the bank bill swap reference rate (BBSW) in the period March 2010 to May 2012. It foloows up with actions against NAB and Westpac.

The BBSW is the primary interest rate benchmark used in Australian financial markets, administered by the Australian Financial Markets Association (AFMA). It is alleged the banks traded in a manner intended to create an artificial price for bank bills.

March 2016: CommInsure payments scandal

The insurance arm of the Commonwealth Bank comes under media scrutiny for operating along similar lines to the earlier financial planning business.

A company whistleblower reveals the measures the bank is taking to avoid making insurance payouts to policyholders, many of whom are sick or dying.

Author: Thomas Clarke, Professor, UTS Business, University of Technology Sydney