A tricky issue – Keeping on top of conduct risk

This month has seen renewed interest in European banking conduct and ethics, and many are now paying the price. European Commission vice-president Joaquin Almunia recently described certain bank misdemeanours as "appalling examples of misconduct", writes Daniel Melo

This month has seen renewed interest in European banking conduct and ethics, and many are now paying the price. European Commission vice-president Joaquin Almunia recently described certain bank misdemeanours as "appalling examples of misconduct", writes Daniel Melo

We all know the payment protection insurance (PPI) mis-selling scandal has cost banks almost £19 billion in provisions. Many other examples of customer mistreatment have also made the headlines, such as IT problems that have led to banking customers being unable to access their funds, and charging customers unlawful fees for late payments.

For those of us in the risk business, it’s particularly galling to now have to deal with the risk from within: ‘conduct risk.’ Conduct risk was defined well by one regulator as "any action of a bank or the banking industry that leads to customer detriment or negatively impacts market stability." Banks must demonstrate to regulators that they are adhering to the rules, especially as the new UK Regulator, the Financial Conduct Authority (FCA), has been discussing its zero-tolerance stance.

It isn’t news that failure to execute business activities in the correct manner — with integrity and discipline — can have disastrous effects on a bank’s financial health and reputation. At the same time, with the rise of social media and mobile, consumers’ expectations are higher. They want fast, excellent service and they are more able and willing to complain when they are not completely satisfied. Ultimately, regulators are now assessing banks against these elevated customer expectations.

Managing conduct risk introduces a challenging scenario for many lenders, as restrictions around what rates can be offered or which customers can be targeted with a particular product can impact profitability. For example, say staff at a particular branch are trying to boost their monthly sales figures by selling high-value long-term savings products to customers in their 80s.

While the sales may make the branch staff happy and add to the bank’s revenue, the products sold are not appropriate to the target group or in the customers’ best interest. They could result in a significant compensation bill, not to mention reputational damage for the bank, should consumers and regulators become aware of the practice.

So what are banks doing about this? We need to have the same controls on our own risk that we place on the risk of our customers. Bbanks need to be able to implement and operationalise systematic conduct risk practices, tracking customer satisfaction and product suitability and running ‘what-if’ scenarios during the entire product lifecycle. Increased regulatory and consumer expectations create opportunities for banks to differentiate themselves and enhance the standard of customer service.

Some banks are taking steps at an operational level to systematically address conduct risk. For example, the most advanced firms are recognising that conduct risk management does not just refer to retrospective issues, and hence are using predictive analytics to factor in various parameters, such as how human behaviour or economic conditions may change the suitability of a product to an individual.

However, such is the complexity of consumer interaction, that banks are no longer able to rely on manual assessments based on expert judgment alone to assess the suitability of a product. Instead, banks are looking at tools such as link analysis, which can factor in numerous data points across sales activities and customer interactions, allowing the bank to dedicate resources to potential conduct risk issues before they become systemic. In addition, decision models can be developed that include a broad range of conduct risk inputs and other variables to identify decision strategies that balance profit, regulation and customer satisfaction. A fully operationalised, analytics-driven framework will help harness and manage conduct risk exposure and turn it into a competitive advantage.

Combating conduct risk is an undeniable challenge, but the tools to meet it are at hand. How close do you think we are to having conduct risk officers?