Australia’s Banking Royal Commission: Quo vadis?
Reforming Australia’s banking sector can only strengthen a Financial Services Industry that’s already suffering from a deficit of trust
While Australia awaits the final report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry – due 1 February – it’s time to think about what happens next.
Contributing over A$140bn in Gross Domestic Profit annually, Australia’s largest industry is at a crossroads. Uncertainty remains over how the Federal government will respond to the report that could likely have far-reaching ramifications for an industry that employs 450,000 Australians, but which has been shown to inflict harm upon the community it serves.
However, developments both here and overseas provide a roadmap for the way forward. And there are options.
Focusing on long-term performance
The Commission’s interim report clearly concluded; “Much, if not all of the conduct identified can be traced to entities preferring pursuit of profit to pursuit of any other purpose.”
In other words, financial incentives for brokers and customer-facing employees drove the unethical behaviour.
It’s well-known that senior executives and board directors experience overwhelming short-term pressure from the share market for ever-increasing profit growth. Notionally, senior executive remuneration is structured for a balance between short-term and long-term performance expectations.
Global consumer goods company Unilever dealt with this short-term pressure by actively seeking out long-term investors and refusing to release quarterly performance reports. If performance reporting is mandated to emphasise longer-term performance, it could discourage short-term trading and ease the immediate pressure on executives.
So too would a ‘Robin Hood tax’ on share trading. For example, a tax of 0.05 per cent would marginally reduce returns and discourage rapid and frequent short-term trading.
Redefining ‘fiduciary duties’
National Australia Bank chairman Ken Henry’s controversial performance at the Royal Commission opened up potentially the most profound change.
The neo-liberal ideology of free markets and shareholder value maximisation has underpinned the systemic structure of corporate law and current definitions of directors’ duties – that is, the legal obligation of corporate directors to act in the best interests of shareholders.
Corporations are legally obliged to pursue profits for shareholders over other purposes, including where unethical behaviour will maximise shareholder value. And they will be legally liable if they don’t.
In 2006, two government inquiries were conducted in the wake of the James Hardie asbestos scandal. These inquiries examined whether fiduciary duties in Section 181 of the Corporations Act should be broadened from prioritising shareholder interests to those of all stakeholders.
The inquiries concluded that the law shouldn’t be changed, deciding it wouldn’t be appropriate for government to legislate good management practices that managers can be expected to adopt anyway because the business case for ethical business was already widely accepted.
The Hayne Royal Commission shows us that this conclusion is wrong. While there is a business case for ethical conduct, there is also a business case for unethical behaviour. In other words, the former doesn’t guide business decision-making sufficiently enough to guard against the latter.
Although the Royal Commission went on to point out that more regulation may not be helpful, over-regulation can crowd out the moral agency of executives – regulations become simply something business people need to find a way around, and fines are accounted for as a cost of doing business.
This kind of over-regulation could be avoided by targeting Section 181 of the Corporations Act as the DNA of corporate decision making.
And there are global examples. Under the Benefit Corporation legal structure in the US, corporations are legislated to serve the interest of all stakeholders. German law mandates employee representation on boards, while the UK explicitly includes other stakeholders as fiduciaries, and defines a longer term of shareholder interests.
Rewriting Section 181 to emphasise long-term shareholder interests would help protect the value creation ability of the firm and reduce the short-term pressures that currently underpin decision-making.
While the Australian Labour Party looks like it will take forward a version of the UK law to the next election, we’ll need to see whether they also take forward the Achilles heel of this law – that shareholders are the only stakeholders who can take action against the directors for not fulfilling these expanded duties.
Moral distance and remediation
A consequence of economic specialisation, compounded by globalisation, is that people can become ‘morally distanced’ from the effects of their decisions.
They make decisions that affect people whom they never meet, and are never exposed to the full emotional consequence of their action. Customers aren’t seen as human beings with rich and important lives, but mere numbers on a spreadsheet.
People were bankrupted and lives upended, yet remediation was delayed and avoided.
So remediation must be improved – it must be quicker, it must be independently managed, and it must include compensation for the hardship caused over and above the financial damage.
The remediation process can also serve to close the moral distance between victims and corporate decision-makers through tools like community panels or restorative justice circles that bring decision makers face-to-face with victims.
Governance of retail banking
The majority of complaints in the Hayne Royal Commission focused on the retail banking sector.
In many jurisdictions globally, there has been longstanding consensus that the rather pedestrian services of savings and cheque accounts, mortgages, personal loans and credit cards are considered to be basic public goods.
There’s simply not much profit in these products and services unless banks can push the boundaries of ethical banking with unnecessary or exorbitant fees. For this reason, in some countries governments still hold considerable control over retail banking.
It’s possible to apply fresh thinking to the way banks organise and govern their different business operations. In the US, the Glass–Steagall legislation provides a template to allow retail banking, as opposed to corporate or investment banking, to be governed by different rules.
This can extend to the way front-line staff should or shouldn’t be incentivised.
Consumer responsibility and education
While many of the behaviours exposed at the Royal Commission can be considered legally unconscionable, customers vary in their vulnerability and so, their share of responsibility.
This is especially true in the case of overstating incomes, where many customers have tended to think that if a bank lets them have a product then it must be ok.
Banks are now instituting much tougher income verification processes, but more education of customers is needed to increase the level of financial literacy, ideally in high school, so that they increasingly take responsibility for their financial relationship with their banks.
The most forceful criticism of all of these proposals for reform is that they will have an adverse impact on profitability, shareholder returns and damage institutions’ ability to compete globally. This isn’t the case.
Far from the damage feared, these reforms can strengthen a sector that is already suffering from a deficit of trust.
Australia needs a strong finance industry to prosper and grow, but it cannot achieve this without the pain of long-term reform and a redefinition of what ‘value’ really is.
Banner image: Courtesy of the Herald Sun