Australia’s biggest banks and insurers have been bracing themselves for a blistering denunciation from the royal commission’s interim report.
But they have also been consoling themselves with the idea that, once all the furore died down, life was likely to continue pretty much as it had in the halcyon pre-commission days.
In other words, they completely under-estimated the formidable intelligence, and intellectual courage, that Commissioner Kenneth Hayne would demonstrate as he grappled with the two key questions arising from his inquiry: what has led to such widespread misbehaviour by bankers, financial planners and insurers, and what should be done about it?
Like many before him, Hayne was quick to identify an overwhelming motivation: greed.
As he argues in the royal commission interim report, “the conduct identified and criticised in this report was driven by the pursuit of profit – the entity’s revenue and profit and the individual actor’s profit. Employees of banks learned to treat sales, or revenue and profit, as the measure of their success.”
But even the dimmest banker realised that the industry’s remuneration practices were going to come in for particular scrutiny by the Hayne royal commission.
And so, with various degrees of enthusiasm, banks have been moving to realign their pay structures, so that employees were rewarded for intangible factors such as adhering to proper behavioural standards as well as for the profit they generated.
As a result, bankers appearing before the commission were able to boast that they were using a more enlightened “balanced scorecard” approach for rewarding their staff.
Hayne, however, is unconvinced that this modest re-jig of the method used for calculating bankers’ salaries will produce the desired improvement in industry standards. “The banks say that they have changed or are changing their remuneration policies and it will be necessary to look carefully at those claims.”
But, worryingly for the banking fraternity, Hayne’s scepticism runs much, much deeper. He’s profoundly dubious about the pay structure that banks use for rewarding all their employees – from the most senior executives to the most junior employees. This remuneration structure has two parts: a base salary, and then a short term incentive payment or bonus.
Now, Hayne is bemused by the fact that frequently, bank employees receive their bonuses even if their performance is only satisfactory, and they’ve merely done what they’ve been employed to do.
As Hayne notes, “the premise must be that the immediate supervisor either cannot, or will not, adequately manage and supervise those employees.”
More importantly, Hayne notes that profit retains its central position, even in the “balanced scorecard” approach. That’s because employees are keenly aware of what their employers regard as most important.
“When the employee and others in the organisation, included the employee’s supervisors and peers, are remunerated according to how much product they sell, or how much revenue or profit they contribute to the entity, sales or revenue and profit are treated as the goal to pursue.”
Indeed, the report notes that using behavioural standards along with sales performance to calculate bonuses can potentially encourage dissembling by employees.
“If the short term incentive scheme reduces the amount allowed if an employee does not meet some standard (of accuracy, or behaviour) the employee may focus as much upon avoiding error being discovered as upon avoidance of error.”
Another problem is that this method for calculating bonuses still assumes that all dealings between a bank employee and a customer can be measured. As Hayne noted, this is far from the case, particularly in the area of financial advice. “There are often circumstances where it is in the best interests of an adviser’s client or a bank’s customer to make no change to existing arrangements and take no new or different product.”
“It is not easy to measure how often an employee is right to give advice to do nothing.”
But this leads Commissioner Hayne to query whether a much more radical overhaul of bank remuneration practices should be considered – one which stretches all the way from the most junior bank tellers to the very pinnacle of those worthy institutions.
As Hayne puts it, “the unstated premise” in the whole debate about paying bank employees bonuses – that is, that they won’t do their job properly and to the best of their ability unless they receive incentives – needs to be challenged.
Hayne, however, isn’t just asking whether junior staff should stop being given incentive payments. As he points out, rewarding senior executives with handsome bonuses based for lifting profits will reverberate through the entire organisation.
“Providing senior management with incentives based on sales or revenue will inevitably affect how senior management acts with respect to more junior members of staff”, the report notes.
In other words, improving the culture of Australian banks will involve a radical shake-up of their whole, deeply-entrenched approach to rewarding staff, from the chief executive down.
“If customer facing staff should not be paid incentives, why should their managers, or those who manage the managers?”, he asks. “Why will altering the remuneration of front line staff effect a change in culture if more senior employees are rewarded for sales or revenue and profit?”
Little wonder that Hayne notes that this process “may not be easy and may take time.”