Good banking, by good bankers
Good morning, and thank you for inviting me to address this year’s FINSIA Summit.
Three weeks ago I gave a speech in which I outlined the challenges that rapid technological advances pose for financial businesses and regulators alike. The key point in that speech was that technology will change financial business models, and the way financial products and services are delivered. For example, the branchless bank, once unthinkable, is now the preferred business model for many. Banking, once an industry built on people, is moving inexorably toward one built on technology.
The World Economic Forum has referred to digitisation as the single most significant force changing the financial sector today. The International Monetary Fund has gone further , comparing the impact of digital transformation to the steam engine, electricity generator and the printing press for its potential to change the world. All of these innovations have been harnessed by humans to make their working lives easier, but rapid developments in big data and artificial intelligence will potentially remove humans from many areas of the workforce completely. Computers are not just managing mundane processes and carrying out complex calculations. They are increasingly making important decisions that have traditionally required a measure of human expertise; in the financial sector, for example, algorithms are increasingly assessing loan applications or deciding whether to offer customers insurance – and at what price.
Given all that has emerged from the Royal Commission this year, it could easily be argued that’s a positive trend; after all, human decision-makers have not covered themselves in glory. The idea of encouraging decisions to be made by a computer program that won’t be swayed by the prospect of a short-term bonus certainly has some appeal.
But as much as we can all see the amazing advances in technology, people will remain central to the financial system for the time being. Computers might help but, for the foreseeable future, humans will still decide what strategy to pursue, choose which products to offer, select what features they will have, determine how they will be distributed, devise the decision rules by which they are sold, and deal with disputes. What is therefore needed is better decision-making by people throughout the financial sector: certainly among the executives and boards that are ultimately responsible for what goes on in the companies they oversee, but at every other level of an organisation as well. Moreover, correcting flaws in corporate governance and culture will require traits that only humans can provide: leadership, judgement, a deep understanding of the fundamentals of their businesses, a strong ethical and moral compass, and the ability to successfully balance the interests of the company, shareholders, consumers and society in general. The future may be on built on technology, but to get this all right, people are still paramount.
An unfinished journey
In sport, professionalism simply denotes getting paid for your endeavours. In the business world, however, the notion of professionalism is much more specific. A profession, as opposed to a job, usually involves some core attributes: defined knowledge; high minimum entry requirements; adherence to ethical standards; a sanctioning body to enforce those standards; and, perhaps most importantly, a commitment to serving the public in some manner. Put simply, professions typically have a commitment to quality, ethical principles and the public good.
Medicine is a profession; doctors take the Hippocratic Oath pledging (in simple terms, though not actually in practice) to do no harm. Law is a profession; a solicitor or barrister who breaks the law or acts unethically can be struck off by their peers. Engineering, accounting and teaching are other professions. What all these professions have in common are the potentially serious consequences for the public from poor actions. Doctors may make life and death decisions. Lawyers may jeopardise their clients’ basic freedoms. Engineers who build bridges, tunnels and skyscrapers are underpinning the safety of the people who use them.
The banking sector can similarly have material impacts on people’s lives. As I observed in a speech in May, the financial institutions that APRA regulates operate in a privileged position in society, providing products and services that are effectively mandatory to consume, difficult to understand, and of great importance to the financial well-being of individuals. This privileged position is compounded by two other important characteristics of financial products: the difficulty consumers have in judging their value and quality; and the long-term commitment (contractual or behavioural) often involved.
However, the business of banking, at least thus far, is not a profession – although that is not for want of trying by some. Indeed, Finsia’s own origins go back to 1886, when Henry Gyles Turner was elected as the first President of the newly-formed Bankers’ Institute of Australasia to ‘drive improvements in professional practice and high standards of conduct’. The Securities Institute of Australia came along quite a bit later, but with a similar goal for stockbroking. But the strength of these organisations peaked when the industry was highly regulated. As the business of finance was deregulated following the Campbell Inquiry in the early 1980s, the boundaries of the financial sector began to blur. Even though the lifting of regulatory shackles may well have been the perfect time for the establishment of stronger professional standards, the liberal ethos of the time meant the development of greater professionalisation, and corresponding corporate and personal restraint that come with it, was a tough ask – akin to swimming against the tide.
Nevertheless, it is both timely and welcome to see Finsia returning to its roots by making professionalism in financial services central to its purpose. As I said in the speech in May, the combination of compulsion, opacity and materiality inherent in many financial products generates, as a quid pro quo, a heightened expectation that financial institutions will exhibit high standards of behaviour in the way they operate. Yet none of the industries APRA regulates is a profession in the way I described it earlier: there is no defined body of knowledge or high entry standards for those who perform key roles. Where codes of conduct exist, they are often totally voluntary. And on the evidence before the Royal Commission, the balance between self-interest, company interest and serving the community’s interest has not always been appropriately struck.
What destination are we seeking?
When the status quo is unacceptable, something must change. But before deciding on what to change, it is always helpful to know what we would like the system to deliver. In other words, what does a good financial system look like? I’d like to suggest we could summarise it as follows:
- the system, and institutions within it, are financially sound and resilient;
- the outputs, operations and connectivity of the system are efficient;
- markets are competitive;
- consumer outcomes are fair; and
- participants are accountable.
All of this would be underpinned by a regulatory architecture that is coherent, and regulatory practices that are effective and cohesive.
In this world, participants would understand and comply with the law, and promote a culture that gives primacy to this. Boards and executives would be clearly accountable for the financial performance (profit), financial resilience (soundness) and conduct (behaviour) of their organisations. Third party intermediaries would have primary regard to the interests of their clients. Industry bodies, to the extent they played a self-regulatory role, would take that role seriously and be equipped to impose strong discipline on industry participants. And regulators would focus on material risks, utilising the full range of tools in their toolkit, to intervene effectively and promptly to prevent, prohibit or sanction behaviour that was inconsistent with the characteristics I referred to earlier.
In such a world, consumers could reasonably expect that the financial system operated fairly – delivering clear and reliable information, true-to-label products, and transparent pricing – thereby equipping them to make responsible and informed decisions.
Unfortunately, we are not in the world I have described. On some dimensions – financial soundness and resilience, in which APRA takes a primary interest – the system is in good shape. The system is also fairly efficient. Many would argue that it would benefit from a stronger dose of competition, however. And issues of fairness and accountability are at the heart of why we have a Royal Commission.
Adding an ethical compass
Central to many issues highlighted at the Royal Commission have been the competing interests and obligations that large financial institutions and their employees face. The community demands they put their customers first. The law says directors must put the (long-run) interests of their companies first. And shareholders (or at least those who manage shareholders’ investments) demand an unrelenting focus on the short-term prospects for the share price and dividends.
Sometimes, these interests naturally align: an innovative new product or service can be welcomed by customers, enhance the company’s long-term prospects, and deliver an immediate profit boost. But sometimes they will not. For example, we have seen on a number of occasions that institutions have declined to do what they think is right because of ‘first mover disadvantage’. If the disadvantage comes from a perception that the long-run interests of the company will be damaged, it may be a legitimate concern. But more often than not it is a concern about the short-term profit (and share price) impact that dominates decision-making.
The Commissioner’s Interim Report sums up the root cause of the issues he has explored with brutal simplicity: ‘too often the answer seems to be greed – the pursuit of short term profit at the expense of basic standards of honesty’. As to why this occurred, the Commissioner is equally clear in his view: ‘from the executive suite to the front line, staff were measured and rewarded with reference to profits and sales’. To the extent this produced misconduct, ‘it either went unpunished, or the consequences did not meet the seriousness of what had been done’.
I’m not going to give a full response to the Royal Commission here – that will appropriately be done through our submissions and evidence to the Commission itself. But the Royal Commission has suggested, amongst other things, that regulators can and should do more to actively enforce standards of behaviour within the financial sector, and punish those who breach them. Based on what has been revealed, that is a quite reasonable conclusion. Consistent with prudential supervisors around the world, APRA has traditionally examined cases of poor conduct as an indicator of risk, but not a direct prudential risk in and of itself, unless it was likely to jeopardise the stability of the system or an individual institution. We will clearly need to reflect on that approach.
Regulatory initiatives in the pipeline – accountability statements, remuneration restrictions, strengthened governance requirements, greater attention to organisational culture, and more forceful enforcement – will drive change. But to truly generate cultural change within the industry, the task cannot be left to regulators alone. As I have said on a number of occasions, regulators can play their part but cannot regulate a good culture into existence. To borrow an apposite quote, ‘Good banking is not produced by good laws, but by good bankers’.
Professionalism as a pathway forward
Well-designed corporate systems, internal controls, incentive arrangements and consequence management frameworks can all be utilised to promote better collective behaviour in the financial sector. But in the world I described earlier, professional standards would also play an important role at the level of the individual.
Professional standards would identify individuals as having appropriate skills and experience. They would ensure on-going professional development, so that individuals remained competent in an ever-changing world. They would include a mechanism for counselling and, if necessary, disciplining individuals who do not uphold competency and behavioural standards. And most importantly, they would help bring a greater balance to decision-making by providing an ethical dimension to offset short term personal and commercial interests. Finsia’s efforts to bring professional standards into the Australian financial sector via the Chartered Banker designation, which will require individuals to attain core competencies and abide by an individual code of conduct, is therefore very welcome.
Here I would also like to acknowledge the important role being played by the Banking & Finance Oath. As many of you know, the Oath is an effort to reassert a moral and ethical foundation in finance, and begins with the phrase ‘Trust is the foundation of my profession.’ I find it powerful because it is very much a personal commitment by individuals. While regulation and corporate systems work top down, these are individuals seeking to drive change bottom up. There are more than 1,100 current signatories to the Oath – and more than 2,500 people have taken the Oath since its establishment – who have chosen to make a public commitment to acting with integrity. The example they are setting is an important one.
APRA is supportive of both these initiatives because we can see clear prudential benefits: a financier adhering to professional and ethical standards is more likely to take informed, balanced and prudent risks with other people’s money. That can only aid the safety and soundness of the financial institutions for whom they work. But the benefits of professional standards are much broader than prudential – they contribute to delivering all of the attributes of the good financial system that I outlined earlier.
In numerous speeches this year, I have emphasised that while significant attention has been placed on governance and culture within banking institutions, equally important for the long-term prosperity of the Australian community is the strength and resilience of our banking system. It’s important that we continue to recognise and acknowledge that the Australian financial system remains financially sound. APRA certainly continues to work to keep it that way.
As important as that is, however, it does not make the Commission’s Interim Report any less confronting or uncomfortable to read. The report raises serious questions and issues for the financial industry, regulators and policymakers to contemplate, and the Commission will inevitably change many elements of the way institutions currently operate, as well as the way they are regulated. As much as the industry, and those of us associated with it, are feeling the intense glare of the Commission’s scrutiny, I have no doubt it will be for the best. The Royal Commission will ultimately be positive for the industry, as well as consumers.
As the Oath rightly asserts, trust is the foundation of financial services. Those foundations have been badly shaken of late. Rectifying this will not occur simply with the passage of time. It will require enormous effort from everyone who understands the importance of a well-functioning financial system that serves the community. Entire companies, sometimes comprising tens of thousands of employees, must change their policies and cultures. But ultimately it comes down to people – collectively and individually. Everyone in the industry has a role to play.
The Royal Commission process has shone a light on the all-too human flaws that have badly tarnished trust in the financial sector. The increasing dependence on technology may help address some of these issues, by removing those flaws from some decision-making. But it won’t solve the entirety of the problems, at least any time soon.
So the solution is inevitably going to be found in the ethics and behaviour of people. Raising professional standards across the industry provides an important means by which those working in the financial sector can demonstrate a commitment to quality, ethical principles and serving the public good. Like technology, increased professional standards are not a panacea. But they are a very welcome development at a time when the industry needs to demonstrate a commitment to change. Finsia, and those it is partnering with, are to be commended for leading the charge.
 See Peering into a cloudy future, speech at Cuscal’s 2018 Curious Thinkers Conference, 24 September 2018.
 The Global Financial and Monetary System in 2030, The World Economic Forum, May 2018, p14.
 The Long and the Short of the Digital Revolution, Martin Mühleisen, IMF Finance and Development, June 2018.
 Furthermore, the Commission did not give automated programs and systems a clean bill of health, highlighting instances in which they were poorly designed and/or lacked the necessary quality assurance (by humans) to ensure they delivered the desired outcomes.
 Prudential supervision involves important human judgment too. APRA’s roughly 200 frontline supervisors supervise about 600 institutions, who in turn employ hundreds of thousands of people to manage and invest more than $6 trillion of assets. Those supervisors are acutely aware of the gravity of their daily judgements on the beneficiaries whose interests APRA is tasked to protect.
 See Beyond the BEAR necessities, speech at the UNSW Centre for Law Markets and Regulation Seminar, 2 May 2018.
 The efforts of Turner and his colleagues were, unfortunately, too little too late. The establishment of the BIA occurred close to the end of property boom facilitated by a period of poor lending in the 1880s. Moreover, the Australian banking system of the time was characterised by free banking – there was no central bank and limited regulation. The subsequent combination of a drought and declining property prices produced a severe depression and accompanying financial crisis as many banks failed.
 The desired outcomes align relatively readily to the current Australian regulatory architecture. APRA has a mandate for financial soundness and resilience, the RBA takes a keen interest in overall system efficiency, the ACCC is stepping up its involvement in competition issues in the financial sector, ASIC has long been concerned to ensure consumer outcomes are fair, and all have a role to play in making sure participants are accountable for playing their own role in delivering the overall outcome.
 Interim Report of the Royal Commission into Misconduct in the Banking, Superannuation and Finance Services Industry (September 2018), Volume 1, p xix.
 APRA’s approach to prudential supervision of banks is founded and regularly assessed, like most of its peers around the world, against the Basel Committee’s Core Principles for Effective Banking Supervision. These provide 29 principles that represent the internationally agreed and accepted standard for sound prudential regulation and supervision of banks and banking systems. There are no references in the Core Principles to ‘conduct risk’ or ‘misconduct’ as a part of the prudential supervisor’s responsibilities – with the exception that Principle 2 deals with instances where the head of a supervisory agency has been found guilty of misconduct!
Withers, H. (1909), The Meaning of Money, London: Smith Elder & Co