European financial companies have been taking incremental steps in reshaping internal culture for years, but regulators are now pushing for deeper, structural, and sustainable change. Many stakeholders – supervising authorities and consumer associations in particular – have become increasingly vocal about the need to improve the sales culture inside these organizations.
Now the time has come to take action. This September, the European Banking Authority (EBA) published the final guidelines on “remuneration policies and practices related to the sale and provision of retail banking products and services.” The new regulations will get financial organizations to rely more heavily on customer satisfaction metrics, and less on aggressive sales targets, when designing compensation plans for their sales staff.
The guidelines will apply to “remuneration paid to staff employed by credit institutions, creditors, credit intermediaries, payment institutions and electronic money institutions, when selling mortgages, personal loans, deposits, payment accounts, payment services and/or electronic money.”
A few reasons the EBA invoked for instituting the new standards:
- “Significant cases of misconduct and misselling by staff in financial institutions, with poor remuneration policies and practices having been identified as key underlying drivers. Misselling […] caused detriment to consumers as a result of inappropriate, unsuitable or excessively priced products.”
- “Unfair pressure exerted on sales staff that has negatively impacted financial institutions as a result of fines, penalties, settlements, redress, compensation payouts and litigation. Such events have undermined confidence in financial institutions and markets, and have created economic costs to society through the misallocation of resources.”
As we mentioned in a previous blog post, the banking authority had released the draft guidelines for public consultation in December of last year.
The new framework will become effective starting January 13, 2018. Initially, the EBA intended for the guidelines to go into effect starting January 2017, but, recognizing the implications of the changes, has decided to give financial institutions more than a year to implement them.
Some of those implications are:
- Significant efforts and costs involved with complying. Financial institutions have to reassess and – where needed – change their compensation plans. This means they must adapt their systems and internal processes to the new regulation. Companies will also need to train their sales staff to treat customers in a manner consistent with the new practices.
- A multitude of approaches from one country to another. These are guidelines, not rules…meaning that they’ll be applied differently by different markets and financial institutions. The EBA has given local regulators two months to answer if and how they will comply with the final guidelines. If local supervising entities do not intend to comply, they will be required to explain the reasoning behind their objections or provide details about the exceptions they plan to make.
Staff earnings have long been under the spotlight in the financial world. Over the past few years, European regulators have mainly reacted by capping bonuses for senior executives. From this point of view, the new EBA guidelines are now going full circle, expanding control across hierarchies and down to the people who actually put products and services into the consumers’ hands.
Across the industry, perceptions about new regulations have always differed. Are they limiting or helping businesses? To what extent should regulators get involved in the relationship between bankers and customers?
It is tough to draw the line when dealing with such complex issues.
Let’s take a look at the impact the new EBA guidelines will most likely have on the employees, processes and overall infrastructure of financial organizations.
Here are some key directives articulated in the guidelines:
1. Institutions should not design remuneration policies and practices that:
- solely link remuneration to a “quantitative target for the offer or provision of banking products and services”; or
- dishonestly promote certain products that are “more profitable for the institutions or for a relevant person, to the detriment of the consumer.”
Instead, companies should establish variable remuneration by taking qualitative criteria into account, such as outcomes for consumers or client retention.
2. Targeted organizations should ensure closer collaboration between HR, Compliance, and Risk Management departments.
The guidelines assert that: “The Human Resources function of institutions should participate in and inform the design of the remuneration policies and practices. In addition, where established, the Risk Management and Compliance functions should provide effective input for the design of the remuneration policies and practices. “
This is consistent with the “four eyes principle” also known as “maker-checker” – a central method of authorization in financial institutions. According to it, at least two individuals must approve all major decisions to ensure their soundness.
3. Financial organizations should store data related to sales staff remuneration for five years.
Also, institutions should make data on remuneration policies and practices available to the competent authorities upon request.
Here is what the banking authority wrote:
“Documentation should include, but is not limited to:
a) The objectives of the institutions’ remuneration policies and practices;
b) The relevant persons falling within the scope of these policies and practices; and
c) How remuneration policies have been implemented in practice, including in particular the criteria for variable remuneration.”
Since this third guideline is easier to meet than the others financial institutions are most likely already in or approximating compliance with the standard.
Reactions from Key Financial Players or Stakeholders
During the public consultations, EBA received responses from 27 entities (banks, banking federations, associations and others). The industry reacted mostly under the umbrella of associations or other representative entities, without assuming a leading position one way or the other.
Still, when several responses were made public along with the final guidelines, it became clear that, while some respondents seemed comfortable with the new protocols, others questioned their purpose.
Barclays “is supportive of this initiative and its focus on ensuring good customer outcomes by embedding appropriate standards into remuneration policies and practices across the industry.”
The European Banking Federation, on the other hand, notes that “similar consumer protection provisions are already incorporated in various EU rules.” However, the Federation recognizes the “much broader scope of application” and the “more detailed requirements” of the new EBA guidelines.
The Austrian Federal Economic Chamber Division Bank and Insurance stressed that “the business model of a retail bank naturally focuses on a good and fair relationship with customers.” They continue: “Therefore we do not agree to the statement that sales staff is currently motivated to missell banking products to the consumers. The CRD IV regulations are detailed enough, so there is no need for further regulation in this field. […] Additional regulations would make it more difficult to strengthen the capital basis and also to attract the best sales staff on the market.”
The European Savings and Retail Banking Group points out that “consumer interest is not immutable, but constantly changing.” Therefore, the entity advises “not to pursue a too rigid and inflexible concept of consumer protection.”
It is expected that financial groups will grow more assertive in the coming year, after determining how they will apply the new standards.
European Guidelines, National Interpretations
Even before the new guidelines were released, numerous countries had taken steps to increase control over compensation for sales staff in financial companies.
Here are a few examples, as reported in the Ernst &Young Conduct Risk Barometer 2016:
- France — Major banks have been changing remuneration schemes to focus on quality of advice rather than quantity of products sold.
- Netherlands — A new law was approved in January 2015 that limits the amount of remuneration per year.
- UK — The Financial Conduct Authority (FCA) has focused heavily on incentives for senior management and sales staff. Malus and clawback adjustments relating to conduct risk are considered annually and bonus pools can be adjusted following conduct risk consideration.
- Belgium — Financial Services and Markets Authority (FSMA) is focusing on incentivization.
Entities around the World also Signal the Need for Sales Culture Change
Of course, concern about a responsible sales approach inside financial organizations is not limited to Europe. Entities from the US share the view that sales culture might need to change to the customer’s benefit, although no similar initiatives have yet been announced or formalized.
According to a report on banking conduct and culture published in July 2015 by The Group of Thirty, “desired values and conduct should be reflected in the daily habits and practices of employees—how they work; how they are evaluated; who is hired, promoted, and rewarded, and how employees act when managers are not present and when matters of personal judgment arise.”
The recent Wells Fargo case serves as a reminder of the need to question and – very possibly – reshape processes, systems, and ultimately organizational culture. The cost of not implementing the required measures can become incredibly high.
Finally, Consumers International (CI), one of the most vocal advocates of customer protection, stated a while back that they were “concerned that until fundamental issues, such as banking culture, are properly addressed, compliance with any new regulations will be undermined.” CI notes that, although there has been some reform of compensation plans for senior executives, financial and non-financial incentives plans for retail staff “have not been adequately addressed to deliver root and branch reforms.”
CI also warns that reckless selling can turn into a systemic risk if it is not properly controlled: “Sales incentives schemes pose a particular risk in the banking sector due to their impact on financial stability. If a bank expands its sales and loans it will make higher short-term profits, regardless of whether the products are appropriate or the consumers can repay the loan. However, once asset prices fall and those consumers start to default on their loans, the bank will take significant losses.”
The concerns echo memories from a not-so-distant past.
So maybe by continuously taking small but vital steps, the industry will ensure higher long-term stability.
Do the New EBA Guidelines Affect Your Organization?
If so, then ask yourself:
- Do you have a solid compensation plan design? Will it work under the new guidelines? Will your incentive-plan modelling prevent misjudgments and errors?
- How much are you involving departments other than Sales when designing your incentive plan? Are you cooperating enough with HR or Compliance?
- If you’re pushing forward a radically new type of compensation plan, how much are you involving experts (internal but also external)?
- If you’re embracing the new guidelines, do you know how to capitalize on them?
Building the Foundation for Sustained Growth
Resisting change is no longer an option for banks and other financial organizations providing retail products and services. In the financial world, it’s not unusual for plan designs remain unchanged for five years – sometimes even longer. In contrast, faster-moving industries – such as information technology or telecom – adjust their plans at least once every twelve months.
It is easy to perceive the new regulation as another bureaucratic hurdle that will put the brakes on business development. But regulatory change can also be an opportunity for positive outcomes: for example, to catch up with other industries in terms of performance management systems and processes.
Historically, financial companies have been slow to recognize and adapt to change. The new regulations give them a chance to break that pattern, and in doing so reap all kinds of gains. Systemic guidelines open up possibilities to improve current processes, expand capabilities, and build the foundation for sustained growth. I would emphasize that the core driver for such changes comes straight from consumers – so this is all about connecting to their needs.
Don’t wait for January 2018 to begin preparations. The race has already started – in fact, some players are already ahead of the pack. How about you? I’d like to know how the new EBA regulations are impacting your organization. Feel free to drop me a line.