Removing incentives won't stop bank mis-selling

The news that Lloyds Banking Group has
been fined £28m ($46m) by Britain’s FCA (Financial Conduct Authority) for
having a bonus scheme that put pressure on sales staff to mis-sell products
once again brings the spotlight to bear on the culture of banks and
specifically, in this case, retail banks. 
In Lloyds’ case it was not only the benefits of meeting or achieving
targets that created inappropriate behaviour but the sanctions for missing
targets including demotion and base salary reduction that put staff under
pressure. For at least one sales person they felt under such pressure not to
fail that they inappropriately sold products that they could not afford to
themselves and their family as well as their colleagues.

The typical media and political response to incidents such
as this is to suggest that incentives are bad, that remuneration shouldn’t be
related to achieving targets as incentives lead to the wrong sets of

However simply removing the explicit link between sales
performance and pay will not remove the pressure to achieve sales targets.

The pressure comes right from the top. While the new CEOs of
banks may publicly talk about changing the culture of banks, putting the
customer at the heart of the bank, winning through providing a differentiated
service and they may be completely sincere in those sentiments, by the time
that that message is passed down through the organisation to the sales people
at the frontline it will be measured in terms of targets, which will need to be
achieved. Anglo Saxon businesses are run with a performance management culture
where achieving or exceeding targets and 
giving greater rewards to those who meet those targets than those who
don’t  is fundamental to how those
businesses operate. While it may never have been the intention of Antonio
Horta-Osario, CEO of Lloyds Banking Group, that the staff be put under such
pressure that they coerced customers into buying products that they did not
need, by the CEO setting his or her direct reports stretch targets that was the
almost inevitable consequence.

The reason for this is simple: banks are commercial
businesses that have investors who are looking for returns and always have the
option to invest their money elsewhere if the return is better. As such CEOs of
banks are competing for investment and are accountable to their shareholders.
This applies as much to new entrants and challenger banks as it does to the
established banks. All of the new entrant banks without exception have investors
backing them whether it is parent companies such as retailers, hedge funds,
Private Equity funds or individual wealthy investors. Even the building
societies and mutual have to look to the external market for capital and those
who lend capital have options as to where they lend to and are doing to achieve
competitive return.

But is a culture that is about beating the competition,
about achieving the best that you can for your organisation really such a bad
thing? Certainly the impression that many politicians gives is that yes it is. The
sentiments being expressed have strong parallels with the period where some
schools banned competitive sports because politicians believed they were
harmful to children.  It wasn’t good for
children because it meant that some of them would have to experience losing.

The politicians who rally against the banks and banker
compensation schemes can’t have it both ways. On the one hand they say don’t
want those in banks to be incentivised to sell customers products but on the
other hand they want competition. Competition by its very nature requires a
level of aggression, it requires you to play to win and for your opponents to

To demonstrate that they are not solely focussed on
financial outcomes most banks today use a balanced set of financial and
non-financial measures to monitor the performance of the bank and their
employees.   Typical non-financial
measures include Net Promoter Score (NPS), customer satisfaction, numbers of
complaints and staff engagement.  The
argument being that by having a balanced set of measures sales staff are
incentivised to treat customers fairly and to only sell customers what they

Some banks such as Barclays and HSBC have removed all financial
incentives for their staff to sell customers products. Instead their staff are
paid a basic salary with the ability to share in a bonus depending on the
performance of the bank. However, even when that is the case, every customer
facing bank employee who has responsibility for helping a customer to apply for
a mortgage or open a savings account knows that, at the end of the day, when it
comes to the annual performance review whether they have achieved or missed
their financial targets will always be more important than whether they have
achieved their non-financial ones. They know that their opportunity to receive
a pay rise, to get a bonus or to progress their careers is dependent upon their
ability to deliver profits for their bank. The financial incentive may not be
explicit but it is still there.

There exceptions to this. 
A bank that has taken a very different approach is Handelsbanken. At
this bank if the profitability exceeds the
average rate of its peers, then surplus profits are put into a fund and
distributed to all the staff. However they can only receive these accumulated
benefits when they turn 60, thus encouraging long-term thinking and loyalty.
The staff, including the executives, have flat salaries with no bonuses. There
are no sales or market share targets. Handelsbanken has very high customer
satisfaction and is highly profitable. The bank has had no problems with
mis-selling or wrongdoing.

However this model will
not suit everybody. This is very much a Scandinavian model and the pace of
growth whilst highly profitable will not be attractive to all investors. Detractors
of this approach will argue that no highly talented executive would be
attracted by this reward model when there are banks across the globe prepared
to reward more in the short term. The sustained excellent results that
Handelsbanken have delivered speak for themselves.  Handelsbanken  would probably argue that it has no desire to
attract the sort of executives who are interested in only the short term and
will move from bank to bank simply for better rewards.

Given that the reality
is the Handelsbanken model cannot and should not be imposed upon all banks,
is the answer and how can this type of mis-selling be avoided in the future?

The reality is that it will never be totally eliminated. Indeed
if there were never any complaints or if there were never any practices that
could be open to question it would suggest that the hunger to be the best, the
passion to grow the business was missing. Every sportsman who wants to be the
best knows that you have to go the edge to succeed.   There will always be employees who are too
aggressive or dishonest. It is that they are identified and the way that they
are handled that sends out the signal to their fellow employees as to what is
acceptable behaviour. That has to be called out loud and clear and demonstrated
by actions from the top of the organisation.

Secondly, while many banks operate
a balanced scorecard of financial and non-financial metrics to measure the
performance of the bank, the financial rewards need to be truly aligned to that
Scorecard and not just to the bottom line. Not only must reward be aligned to
the scorecard it needs to be seen to be aligned. This means that for instance if
customer satisfaction or employee engagement scores are part of that scorecard and
those measures are not met or regulators impose fines despite financial targets
being met, that the executives’ rewards are significantly financially reduced.
This is something that has not been reflected across the banking industry
despite the enormous financial fines handed out to the likes of JP Morgan and

Thirdly there needs to
be a recognition by investors that the days of retail banks being a licence to
print cash are over, that most banks need significant investment both in terms
of capital to fund the business but also to provide the infrastructure that a
bank needs to have to compete in the 21st century and finally that
an investment in a bank is for the long term – measured in double digit years.

Changing the culture of retail banks is not as easy as
simply removing incentives, neither it is something that can be done overnight.
To have a vibrant and competitive banking industry there needs to be some
friction and a world without it will be a lot worse for the consumer.

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