The ethical sustainability of profits in financial services

Michael Armstrong (FCA), the Regional Director for Middle East, Africa and South Asia at The Institute of Chartered Accountants in England and Wales (ICAEW).
Since the 2008 global financial crisis - considered by many economists to have been the most serious financial crisis since the Great Depression of the 1930s - an enormous amount of work has taken place in financial services firms to fix the various aspects of the industry found to be deficient. Much of this work has centered on conduct, incentives and profits. It has been sponsored by a variety of national and international bodies, and has resulted in a mixture of mandatory regulation and voluntary best practice.

Despite clear financial incentives for ethical behaviour at the corporate level within financial services firms, such as the deterrent effect of very large fines imposed by regulatory bodies like the Capital Markets Authority or the Kenya Revenue Authority, there is evidence that banks remain strongly focused on short-term Return On Equity (ROE) metrics. Meeting these targets can often be at odds with good customer outcomes and distract from the way products and services work for customers.

Even when executives are aware that a particular way of doing business may leave the organisation open to accusations of misconduct and possible financial sanctions, they can still find it challenging to change things and ensure that their people are acting in accordance with the organisation’s mission and values.

For example, higher ROE targets encourage lower costs, which could manifest in lower investment in controls and training. Prioritising these financial targets may mean that staff feel they must pursue sales and profits at all costs. This can create a systemic cultural crisis within the working environment, rather than issues being the responsibility of a few rogue individuals.

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The buy-to-let mortgage market, for example, is a potential high risk area due to the dominance of brokered sales. Given the role played by incentives paid to brokers in past scandals, it would make sense to curtail activity, but this would significantly impact sales and therefore profits.

Issues may also exist in other areas, including ‘free’ banking, back-book savings products, standard variable rate mortgages, 0 per cent credit card balance transfers and car insurance. All these present profits which may not appear to fit with the purpose or desired customer outcomes of the product. Financial services regulators may wish to consider these areas in future.

It would be wrong to think that financial services is alone in this problem. Pursuit of shareholder value above all else has created difficulties and negative consequences in other sectors, leading to unethical behaviour and a loss of customer trust in the long term.

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Accountants can play a critical role in resetting the balance between profit and customer outcomes by pursuing appropriate ROE alongside good customer outcomes. This does not mean there will be a one-size-fits-all ‘good’ level of ROE, or that companies need to reduce their targets. It does however mean that targets should be set more consciously with professional conduct considerations in mind, and not just as an afterthought.

To ensure that individuals, teams and departments are suitably aligned within the organisation there must be a coherent framework for setting ROE targets which also properly aligns risk and reward.

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To facilitate this, accountants need to follow three steps. They first need to identify highly profitable products, that may signal future conduct issues, such as payment protection insurance (PPI). Secondly, they can help to provide a sense check on profits as part of new product governance and evaluation. Finally, they can lead the debate on whether the economics of a product are being shared fairly between the customer and the firm to ensure sustainable profits.

While a top-down approach is clearly essential in terms of setting and managing ROE targets and expectations, a bottom-up approach is also needed. This is where finance has a more proactive role to play in bringing more transparency, information and analysis to the process.

Product profitability, for example, needs to be discussed in more detail, including the evaluation of customer outcomes and the sales processes used. To avoid additional future issues, firms should make product profitability part of their new product assessment and evaluation processes.

It can be challenging for financial services firms to understand how and where they make money at a product and customer level, due in part to the volume of data, age of products and way in which data is collected and presented. However, a greater depth of understanding with regards to product income, costs and profitability is crucial.

Finance teams must be more involved in sourcing and interpreting this data, and should use their expertise and insight to challenge the figures robustly, and bring potential issues to light.  Such action will help deliver better conduct and culture outcomes within firms, helping us to avoid future financial crises.

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The author Michael Armstrong (FCA) is the ICAEW Regional Director for Middle East, Africa and South Asia

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