The Easy Way To Fix Our Big Banking Fraud
Australians have been transfixed and infuriated by shocking revelations from the Royal Commission into the financial services industry.
Commissioner Kenneth Hayne heard tens of thousands of incidents of misconduct by banks and other financial firms, confirming a clear pattern of misconduct: from breaches of community expectations and norms of responsible lending, to outright fraud and lies. The problem is not a “few bad apples”; the problem is clearly rooted in the core structure and practice of this industry.
However, when it comes to fixing this mess, the Commission’s recent interim report asked more questions than provided clear answers. Stronger laws and regulations, and better enforcement of those laws, are an obvious response. But the Commissioner acknowledged that top-down oversight alone won’t achieve the wholesale changes in culture and behaviour that are needed: “Passing some new law to say ‘Do not do that’ would add an extra layer of legal complexity to an already complex regulatory regime,” he wrote. “What would that gain?”
Others advocate better consumer education (so Australians can be more wary of banking scams) or expanded self-regulation by financial firms (in essence letting banks police themselves). At best those strategies are wishful thinking; at worst they represent a PR effort by the banks to avoid more serious interventions.
There’s another solution to banking misconduct that Commissioner Hayne has so far overlooked. Flawed pay systems have created perverse incentives for banks and brokers to push debt, insurance, and financial services to Australians -- whether they need those products and services or not. Financial professionals can reap tens or hundreds of thousands of dollars in commissions, bonuses and “introducing” fees; top executives pocket millions.
Inevitably these incentives lead them to sidestep or ignore basic rules and standards: like knowing your client, transparency and responsible lending.Consumers, many of them vulnerable, end up with expensive commitments they didn’t need or (in many cases) even understood.
This pattern of “conflicted compensation” (which actually rewards financial staff for undermining their clients’ best interests) is an acknowledged root cause of financial misconduct. But hoping that any single bank will voluntarily change its practices and adopt higher ethical standards ignores the impact of competition on bank behaviour: no single bank will reform its own compensation practices, if that allows rivals (using the same old bad tactics) to capture more market share.
There’s an obvious solution to this quandary: the financial industry must implement a uniform compensation system, consistent with principles of ethical banking, right across the whole industry.
Professionals can be paid consistently (including bonuses for personal or group performance, where appropriate), while protecting the best interests of financial consumers. And a reliable and independent system of enforcement, embedded within financial firms, can ensure the rules are being followed.
How could this more ethical, level playing field be established? Through a sector-wide collective bargaining system. Employer and union reps would negotiate standard compensation patterns that apply to all participants across the industry. Compensation in each job would be tied to qualifications and experience; separate pay grids could be specified in various branches of finance (including major banks, insurance, superannuation, and financial advice).
Clear and enforceable limits on sales- or revenue-based incentives would be specified -- eliminating a key motivation for misconduct. And a sector-wide agreement would also include accountability and reporting mechanisms (protecting those who report wrong-doing), and clear benchmarks for qualification, certification, and ethical practice for employees at all levels.
Through sectoral agreements, rational, ethical and consistent compensation principles could be implemented across the whole financial industry. Better yet, this system does not rely solely on external regulators to monitor behaviour and investigate complaints. Instead, the enforcement of standards would become part of the regular administration of the collective agreement, rooted in day-to-day oversight by hundreds of managers, union stewards, and delegates embedded throughout the “machinery” of the financial industry.
After all, the whole point of a collective agreement is to establish clear, consistent and enforceable rules for what happens in a workplace. In this case, those rules would help improve the ethical practice of the whole industry, as well as improving wages and working conditions for the people who work there.
Clearly Australia’s banks need more rules, not less -- and a more embedded and effective structure to ensure the rules are followed. By establishing sectoral collective agreements as a foundation for ethical, professional behaviour, the perverse conflicted interests exposed by the Royal Commission can be eliminated. Moreover, by specifying those norms on a consistent, transparent and sector-wide basis, this approach would ensure that competitive pressure does not inhibit financial providers from reforming compensation practices.
Unfortunately, Australia’s restrictive industrial relations laws generally prohibit collective bargaining on a multi-firm or sector-wide basis. These restrictions are unusual: most industrial countries permit, and even encourage, multi-firm, pattern, or industry-wide bargaining as an efficient way to determine consistent benchmarks for pay and conditions, and ensure that ongoing economic and productivity growth translates into rising living standards. Even the Organization for Economic Cooperation and Development has confirmed that more “coordinated” forms of bargaining allow economies to achieve better employment outcomes and reduced inequality.
Australia’s unique and restrictive collective bargaining rules should be reconsidered in light of pervasive financial misconduct -- and the key role of perverse compensation systems in motivating that misconduct. Sectoral collective agreements could play an effective role in reforming compensation and reducing financial misconduct on a uniform, industry-wide basis.
The Royal Commission should now explore standardised sector-wide collective agreements as a promising response to the problems it has so damningly documented. And the Commonwealth government should eliminate its unusual restrictions on collective bargaining so that this important reform could occur.
Jim Stanford is Economist and Director of the Centre for Future Work, based in Sydney. The Centre recently submitted a comprehensive proposal for sector-wide collective bargaining in the financial industry to the Royal Commission.