Australia’s major banks have indicated a willingness to evolve from a sales culture to a service culture but managing this transition will be difficult and how banks change the way they remunerate staff is shaping as a key test of their resolve. Andrew Starke reports.
The collective wisdom since the GFC has been that bankers’ bonuses were at least partly responsible for some of the excessive risk-taking and poor corporate culture that caused the collapse. However, the academic evidence out of Europe is far less conclusive with a survey of academic literature revealing that very little is known about the design of bank-employee remuneration and its effects on bank risk, profitability and financial-sector stability.
That said, few would dispute the position of Reserve Bank of Australia governor, Philip Lowe, who in late September told the House of Representatives Standing Committee on Economics that he would as a priority ensure that “remuneration structures within financial institutions promote behaviour that benefits not just the institution but its client”. In an era where bank CEO remuneration has gone from roughly 10 times that of the average bank employee (in the 1990s) to almost 100 times today, questions will understandably be asked about executive pay when banks fall short on protecting consumer interests. Or as Labor MP Matt Thistlethwaite put it to NAB CEO Andrew Thorburn at the March sitting of the House of Representatives Standing Committee on Economics: “Do you live in the real world?”
Thistlethwaite and Liberal MP David Coleman questioned why Andrew Hagger, NAB’s chief customer officer – Consumer and Wealth, and former group executive, NAB Wealth, was granted a bonus in 2016 given that the bank’s wealth management business was forced to repay $36.5 million in compensation after ASIC found 220,000 corporate superannuation accounts had been overcharged. According to NAB, Hagger garnered $4.08 million in total remuneration last financial year, consisting of a $1 million salary plus bonuses, superannuation and shares. He received $3 million in 2015. Thorburn’s assertion that Hagger had changed roles in order to lead a “lift in standards” and that he had done an “excellent job” was met with derision by the committee.
“Mr Thorburn, I think people might take exception to that … I think a sensible observer would say: ‘who is the boss of this division?’. From a customer perspective this is the problem division of the bank … and the buck needs to stop with the executive,” Coleman said. “Mr Hagger is the boss of this division and what I want to understand is whether Mr Hagger has experienced any consequences from all of these quite serious issues that have taken place in the division he has been running all that time.”
Thorburn argued that many of the problems in the division already existed or were instigated before Hagger took on the role. The overcharging occurred between September 2012 and October 2016 while Hagger took on the role of head of wealth management in April 2013.
While the Parliamentary Standing Committee singled out Hagger’s remuneration package to make a point about executive pay, Stephen Sedgwick last month published the Final Report of his ‘bottom-up’ review into how banks pay and reward all retail staff; offering a total of 21 recommendations and a stark warning that banks must “break with the past”. Specifically, the review looked at the prevalence and effectiveness of product sales commissions and product based payments in retail banking in Australia and the link between payments and customer outcomes.
“The 21 actions I propose, if fully implemented in the spirit in which they are intended, will complement other initiatives the ABA (Australian Bankers’ Association) has underway in the Banking Reform Program and will assist in addressing a trust deficit that has emerged in the banking industry,” said Sedgwick. “They are deliberately intended to signal a sharp break with the past. Changing remuneration alone is not enough. Each bank should address the issues holistically. This means many banks should also revise their target setting, performance management, leader development and, most importantly, culture; and ensure they are aligned with the ethical, customer–centric philosophy that underpins my recommendations.”
Speaking at an AFR Banking & Wealth Summit in April (panel pictured above), shortly before the release of his review, Sedgwick, said pay was an important component of reward and recognition system that drives bank culture but certainly not the only factor. He noted that Australian banks often find it easier to get alignment between the top of the organisation and the front line than with the middle layers.
“There is more of an overall view at the top and the bottom. When your job is to be the group manager of credit cards or the group manager of mortgage lending, then your focus is a lot more narrow. So I think that there’s an interesting task for the banks to ensure that they keep an appropriate balance for the middle managers in their organisations,” he said.
On the same AFR panel to discuss The pointy end of culture: remuneration and reward, Danny Gilbert, managing partner at Gilbert + Tobin and a past Chairman of the NAB Remuneration Committee, said the issue of remuneration and reward was complex with no easy answers.
“The key drivers were to be competitive in the market, attracting the best people and keeping them motivated … and they are still the most important,” he said. “It was hard enough previously to link motivation and reward with shareholder outcomes. That was complicated enough. And if you now add to that pressure from government, pressure from regulators and pressure from the community, it really requires the wisdom of Solomon to get it right. And it will never be right. The house will never be built. Improvement will be incremental but we will never satisfy all of those parties.”
A high-profile example of this difficulty in aligning expectations played out in November when the Commonwealth Bank bowed to shareholder concerns over its executive pay scheme – specifically the meeting of “soft targets” in the calculation of bonuses. Proposed changes would have meant human resources targets and customer satisfaction scores would have an equal stake with financial targets, which currently make up most of the performance targets. Some institutional shareholders are believed to have expressed concern that senior executives at the bank were still getting bonuses despite a series of scandals, including poor advice from financial planners and restricting payouts by CommInsure.
However, CEO of AustralianSuper Ian Silk, said his organisation was very supportive of soft targets if the metrics were in place to measure their impact.
“Despite reports to the contrary, when certain banks have come to speak to us and suggested they change their remuneration structures to include soft targets; we have been very comfortable with that,” he said. “But you can only support it if there’s clear metrics. And in some well-publicised incidences there has been a desire to move to a structure that incorporates soft targets but, frankly, at that stage, no degree of sophistication about how they are going to be measured. And if you ally that with the historical record of many large institutions in financial services having very poorly designed and poorly implemented rem systems … then that’s a recipe for no change at all.”
While conceding that the major banks are improving their metrics around soft targets and creating more “robust systems”, Silk said the financial services sector needed to recognise that many people in the industry receive “exceptional remuneration for good, satisfactory performance”.
“The de facto regarding of STIs (Short Term Incentives) as base pay is a pretty good example of that,” he said. It was a point that Gilbert was willing to concede: “Banks just have to get better at looking at individual performance and not ranking people in groups so much. We have to break away from this idea that STI is normative. We have to change that.”
Prestige and power
Silk has criticised CEO pay levels in the past and, while acknowledging the usual factors such as the “war for talent” and supply and demand, made the interesting point that director brinkmanship might play a role.
“CEOs have healthy egos. The power, the prestige, the power to make positive change ... all of these things are important issues but instead there appears to be a bidding war around CEOs. We find a lot of companies paying more than they need to pay. There is also something that is not often talked about but when you speak to individual directors you get this sense of reflected glory; ‘you’re going to pay your CEO $100 and we’re comparable organisations so I’m not going to pay my CEO $70 because what does that say about my organisation and our respective positions in the market?’ You just hear enough of this talk to say that it’s a factor.”
“If you don’t have your culture right, you’re not getting to get your strategy right, you’re not going to get your staffing right. Pay absolutely impacts culture.”
Speaking on the same panel, RBA director and investor Carol Schwartz, made the broader point that “If you don’t have your culture right, you’re not getting to get your strategy right, you’re not going to get your staffing right. Pay absolutely impacts culture.”
In its Review of the Four Major Banks (Second Report), released in late April, the House of Representatives Standing Committee on Economics acknowledged the progress that is being made to improve culture and accountability within the sector. Specifically it cited: the Government’s decision to allow ASIC to ban managers guilty of poor conduct from operating in the financial services industry; the industry’s work to develop a register of ‘rogue’ employees to help ensure that they cannot rotate between financial services firms; and Stephen Sedgwick’s review of commissions and payments (including referral payments) made to bank staff and third parties to ensure that they do not encourage behaviour contrary to consumers’ interests.
“However, even with these measures in place gaps will remain,” it noted. “Clearly there will be some cases where an executive’s conduct has been sufficient to justify banning. However, not all misconduct is severe enough to warrant ASIC taking this action. The proposed framework does not strengthen the consequences for responsible executives where banning would be excessive, but where mere reputational or remunerative penalties are grossly inadequate.”
This ties in with Sedgwick’s view that any bank pay reforms must signal “a sharp break with the past”. A former Public Service Commissioner, Sedgwick was appointed by the ABA to review how bank tellers and other customer-facing bank employees, their managers and third parties are paid by banks. The review is part of the ABA’s Better Banking reform package, which aims to protect consumer interests, increase transparency and accountability and restore trust and confidence in the industry.
Shifting from a sales-focused culture
While the extent of change required will vary, almost every bank will need to change at least some of its practices to comply with Sedgwick’s recommendations. These include: no longer paying retail bank employees incentives based directly or solely on sales; examining workplace culture and leadership frameworks to ensure they are aligned with good customer outcomes; and increasing transparency of remuneration arrangements with third parties, such as mortgage brokers.
ABA chief executive Anna Bligh said the banking industry supported the recommendations made by Sedgwick and would implement them in full as quickly as possible.
“Mr Sedgwick has not only identified that remuneration arrangements need to improve, but also that it needs to happen alongside a change in culture and approach from management,” she said.
“Banks don’t underestimate the changes recommended by Mr Sedgwick. This will not be easy for banks and there will be challenges. Changes will need to be made to bank policies, workplace agreements, contracts, staff training programs, internal controls, and performance management systems. This is not just about payments; it’s about governance and leadership. It’s not just about bank tellers and their managers; it goes up the line. Banks have heard the criticism about the sales culture. The industry needs to embed a customer-focused culture so customers have confidence banks are doing the right thing by them.”
“This is not just about payments; it’s about governance and leadership. It’s not just about bank tellers and their managers; it goes up the line.”
Bligh added that individual banks would take action to make changes to their businesses, while any industry-wide response would need to consider competition and other legal obligations. NABs Hagger described the recommendations as a significant step for the industry, adding that it would require focus, discipline and strong leadership to implement them. In relation to the recommendations that impact third parties including mortgage brokers and aggregators, NAB agrees with Sedgwick that any changes to their remuneration structure should be “viable” and “competitive”.
“We see mortgage brokers and other third parties as an important part of the future of our business. We will be working closely with the industry, Treasury and with the regulators, ASIC and the ACCC, to make sure we get the right result for our customers and the industry,” said Hagger.
ANZ also confirmed its commitment to implementing the recommendations with group executive Australia, Fred Ohlsson, explaining that ANZ had already introduced a new ‘balanced scorecard’ incentive plan in its Retail Banking Branch and Contact Centre businesses.
“While we have already taken significant steps to improve our remuneration structures, we know there is real concern in the community about the sales culture within banks and I’m confident these meaningful reforms will provide better outcomes for all customers,” he said.
In a statement, Commonwealth Bank of Australia chief executive, Ian Narev, called the Sedgwick review “thorough, robust and independent” and committed CBA to implementing all of the recommendations.
“Over a number of years the bank has been working across a range of areas, including culture, people management, and incentives, to improve customer outcomes. The Sedgwick recommendations will accelerate that work.”
“Over a number of years the bank has been working across a range of areas, including culture, people management, and incentives, to improve customer outcomes. The Sedgwick recommendations will accelerate that work by further encouraging our people to provide great customer service,” he said.
“We will implement many of the recommendations by 1 July 2017 and will have all changes in place by the following financial year.”
APRA’S REVIEW OF INDUSTRY REMUNERATION PRACTICES
Present bank remuneration requirements are contained in CPS 510 and were introduced by the Australian Prudential Regulation Authority in 2010 for ADIs and insurers. The fundamental principle underlying these requirements is that performance-based components of remuneration must be designed to encourage behaviour that supports: the regulated institution’s long-term financial soundness; and the risk management framework of the institution.
According to APRA, remuneration frameworks - and the outcomes they produce - are important barometers and influencers of risk culture. Last year the regulator committed to conducting a stocktake of current industry remuneration practices to gauge how well existing requirements are being implemented, and how they are interacting with the risk cultures of regulated institutions. This will include reviewing the remuneration arrangements and outcomes for some senior executives, risk and control staff and material risk-takers at a sample of institutions.
APRA will also use this opportunity to compare its remuneration requirements with more recent international regulatory developments and supervisory practices. The work commenced in 2016 and will is continuing this year. Fahmi Hosain, APRA’s head of governance, culture and remuneration, said remuneration was a major focus for the regulator at the moment following research on risk culture released last year.
“Since we’ve introduced those requirements back in 2010 our focus has largely been around policy settings,” he said. “We are now moving to a point where we want to truly understand the outcomes we are seeing from those policy settings. What does this actually look like in practice?”
WHAT WILL SEDGWICK CHANGES MEAN FOR RECRUITERS?
Randstad senior consultant Roland Youakim told AB+F that he was watching two key areas after the Sedgwick recommendations: the remuneration of aggregators and mortgage brokers; and the removing of variable rewards linked directly to sales.
“The mortgage broking industry do not seem to support Sedgwick’s report (see page 8), like they embraced ASICs reviews and recommendations. However the banks will need to change the scorecards of all sales staff involved in providing home lending solutions for customers. This is where we see significant changes for recruitment,” he said.
“In the Mortgage Broking space there is some uncertainty at the moment, hence recruitment is not dead by any means, but the industry is sitting steady to see what happens in the upcoming months. We predict the earning potential of mobile bankers, branch bankers and lender BDMs (that drive product to mortgage brokers), will change. There are currently some very lucrative models where scorecards are based 70-90 per cent on drawdowns (settlements). There are some lending institutions with BDMs that earn upwards of $400K per annum on these scorecards.
"There are also mobile bankers in the market that earn upwards of $30K-50K per quarter (based on similar scorecards focused on sales), in addition to their salary packages. These are the scorecards that will likely be affected, and we predict that the Sedgwick report will create consistency across the market, where most lending institutions will have similar earning potential. So this will likely make recruitment far more focused on everything else such as the reputation, brand, culture, career development etc. Hence this should create more competition for Institutions to be attractive employers, and not just employers that pays the best salary and bonuses. So how candidates/job seekers will choose an employer is likely to change.”