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The value of 'trust' in financial institutions

The 1997 Nobel Prize winner and distinguished academic, Robert C. Merton, was in Sydney last week, and we talked about the value of 'trust' in financial institutions. He argued trust is a key strategic asset which creates growth opportunities and defends against competition. It allows deeper customer engagement across products and services. Then in a presentation at Dimensional Fund Advisors, he spoke specifically on the trust problems faced by fintechs:

"There will be strong challenges for change to the areas of financial services involving processes (eg clearing and settling, title insurance, payments) and in any activity that involves little judgement (since) transparent services do not require trust.

FinTech alone will have greater difficulties in disrupting services and products which are 'inherently opaque' (ie cannot be made transparent) such as financial advice, solutions and most integrated financial products. As with medical advice, the only means of providing those services and products is through trust. Technology by itself is not a substitute for trust.

Technology to succeed will have to partner with providers that can provide the trust asset, since it cannot create trust by itself."

We'd be interested in reader comments on the 'trust asset' at the Commonwealth Bank in the context of the AUSTRAC investigation and the financial advice and personal insurance issues in recent years. The Bank just announced an increase in net profit to $10 billion, a rise in annual dividend to $4.29 rewarding 800,000 shareholders and 333,000 new home loans in FY2017. Looks like plenty of trust there, but The Australian Financial Review called it "the contradiction of the country's most hated company".

Do you agree with Merton? Is it really that difficult for a new fintech to build trust?

In this article, former senior bank executive, John Chauvel, offers his perspective after experience on both sides of the fence.

Banks, fintechs and trust

John Chauvel

Trust has been on the minds of bank CEOs lately. Many of the products and services they offer are sold on the basis of trust, although customers also require good service and value for money. The ‘bundling’ of banking products around trust has seen Australian banks become the largest companies in the country. Bundling has been sensible for both the bank and the customer, but does it make sense going forward?

The seeds of trust come from the banks’ deposit taking capabilities. Back in the 17th and 18th century, merchants stored gold for safekeeping with locksmiths with private vaults. The locksmiths issued ‘receipts’ of ownership, which could be used as currency for conducting trade because they were backed by gold, the most trusted store of wealth.

Trusting banks

This is similar to banking today when depositing money with a bank. The deposit appears as a ‘credit’ balance in my bank account (or an entry on the right-hand side of the bank’s ledger indicating they owe me money). Through a combination of the bank’s reputation, regulation and a guarantee from the Australian government (via the Financial Claims Scheme) I am so certain that this ledger entry will be honoured that I think of it as money.

Once the bank stores my money for safekeeping, it is natural for me to trust them with transferring it to third parties. I need 100% confidence that this can be done properly so I can do normal things like buy food, shelter and settle debts. Banks over many decades have built complex systems to ensure transactions like these are performed promptly, accurately and reliably.

The trust we have in a bank’s ability to store and transfer money is so profound that, in fact, any time we think of doing anything with money we naturally think of a bank. Like for example, how to convert it, invest it or borrow it. Banks have become good at bundling these other services because of their proximity to our money and their ability to leverage the existing systems they have. However, the provision of these services rely less on trust and more on good service and value for money.

Borrowing is different to depositing

Take borrowing for example. If I have borrowed money from a bank, do I need to trust the bank to be able to repay my loan?  Of course not, as the entire trust equation is reversed. The competency to lend money is completely different from the competency to store and transfer it. However, because of trusted relationships, access to personal financial information, the cost and complexity of data management and integrity and, quite importantly, access to capital, banks have had little competition for the provision of this service.

From a borrowers’ perspective I should be most attracted to the lender who is best skilled at assessing my credit risk, offers me the best terms and conditions, offers me the lowest interest rate and can fund me when they say they will. With the development of financial technology (fintech) and dis-intermediation, the party who can do all this is not necessarily a bank.

If a mortgage is broken down into its parts - including designing the loan, assessing the borrower, processing and funding – banks do all of these things, but so can a lot of other companies. And often they do them better.

Unbundling of trust

It is unlikely the unbundling of trust will come about overnight, but it has begun.

Banks have ceded much of the customer service function in loan origination to mortgage brokers. They have spent billions building integrated wealth and insurance businesses on the presumption that cross selling these products would increase their rate of return, but instead have generated poor returns and reputational damage. They have pulled back from business and corporate lending, which have been a drag on shareholder returns.

Policy makers have long questioned the efficiency of banks borrowing billions of dollars in wholesale domestic and offshore markets just to hold loan assets on their balance sheets. Wholesale investors can, arguably, hold these loans just as effectively.

Fintechs and technology do things better

Fintechs are adept at using technology to do things smartly, quickly and cheaply. In many cases, they provide a better product for the customer than banks, particularly activities that require good service and value for money, like online lending. Access to wholesale capital markets removes a further layer of intermediation and cost. Banks will try to replicate fintechs, however, trust aside, the playing field has become a lot more even today than it was a decade ago.

The core competencies that banks can retreat to are deposit taking, transaction banking and liquidity management which require access to liquidity when needed. However, even some of these are under threat from fintechs. The ‘distributed ledger’, aka blockchain, challenges one of the core reasons for a bank’s existence, as a trusted store and transferrer of money. In offering a completely different basis of ‘trust’, these new technologies eliminate the need for the trusted intermediary role that banks have played.

Moreover, this new generation of technologies does not rely on the vast and expensive IT systems the banks have invested in, and have no doubt viewed as a source of ongoing competitive advantage.

Big banks face a great and possibly existential challenge. New entrants offer niche products and services better targeted to customers. Technology drives down costs and turns scale on its head. Open architectures and new regulations enable information exchange undermining the power of incumbency and assumed trust.

Bank CEOs possibly have more than just trust on their minds.


John Chauvel is a former senior debt capital markets executive with a major bank and a current fintech entrepreneur. 

We welcome your constructive comments on this article, Robert Merton's opinions, events at CBA and whether the case for a banking Royal Commission has changed.


August 15, 2017

I believe that the key problem with the way the CBA deals with this unfortunately lies in defining exactly what the bank means by "trust" and what the client understands by "trust".
The bank would like to imagine they maintain a deep level of trust with their clients, and this is often cited by executives such as Narev and Livingstone. It can be represented as an almost mystical relationship between the bank and the customer, the holy grail of banking. Yet, delicate and fragile as this thing is, it can often be represented as a significant element within the bank's intangible assets.
Unfortunately, if you asked the client about what "trust" was and how they understand this within the bank, they might reply that "they trust the bank to keep their money safe and their account secure".
Would they trust the bank to put the customer's interest before their own? Somehow I doubt it!
The trust you place in the bank is more like the trust you implicitly understand when dealing with sharks. Primitive eating machines with only two principle objectives; to swim and to eat, yet you can place trust in the fact that, if there's blood in the water they will look for, and devour, its source.
If the banks want to understand where real "trust" can be found, then they should look at the consumer survey of trust in the professions. Genuine trust isn't just bought through marketing campaigns, it has to be earned through long-term commitment and deep-seated professional obligations to patients and customers!

Erica Elliot
August 14, 2017

CBA needs to be realistic and make the penalties relevant to management breaches and costs to the organization. Heavy is the head that wears the crown. It is where the buck stops. 53,000 times 18 million (the maximum per offence) is no small matter. It's failure to notify Austrac way back in 2015 that it had a problem with its system meeting regulations is beyond belief. As a CBA customer I have been notified before today that could I could not break the $10,000 deposit rule while moving funds around my accounts. The fact that these deposits came via their deposit envelope/ chute system should have made no difference. What a boo boo!

andrew richards
August 12, 2017

It is true that trust is part of the glue that enables a democracy to function but much of this trust is because of our relationships with individuals rather than institutions. Indeed trust in institutions is broken or breaking whether it's politicians, big business, the media or the church . Young people in my experience are particularly cynical.
The latest debacle at CBA will have done nothing to restore confidence or trust. The Chair says she & the board have full confidence in the CEO. How can she possibly say that knowing the details of the Austrac court papers as highlighted above? It simply isn't credible. Does anyone have confidence in the board, because the buck is supposed to finally stop with them isn't it?
And there is a certain smug way executives explain away serious management failings as if it doesn't really matter because look how successful we are & nothing much will happen to us anyway - which it usually doesn't. They are all too easily able to hide behind the mask of their corporate culture & often deflect blame to already departed executives who were of course " rogues".
And you know what would happen to us as individuals if we were accused of just one instance of money laundering. Orange jump suits...

David Smith
August 11, 2017

I have long held the opinion that penalties for corporate executives for white collar crimes in Australia do not meet community expectations and as a direct consequence, banks and other corporations will continue to do whatever they think they can get away with to make profits. There is no real risk of prison time (albeit there are some minor exceptions) and any financial penalties can readily be met by parting company with some of the ill-gotten gains. If the corporation is fined, it doesn’t impact on the executives or the board – only the shareholders bear that pain. As a straight business decision, the returns to be made in the form of excessive salaries and bonuses vastly outweigh the risks if anyone is actually caught, convicted and personally penalised.

Corporations and their executive staff routinely pay lip service to the notions of ethics and fairness, but their behaviour is at obvious odds with these sentiments. There is no shortage of examples, and CBA is hardly the Lone Ranger.

On this occasion, the CBA board chair has been publicly quoted as pointing out that CBA has spent large sums of money attempting to discharge their AML obligations. There are three points to note on this.

1. The measures were obviously ineffective, so either the strategy or the execution was flawed

a. Logic and decency would dictate that either the board or management (or both) should be held accountable for this – but neither show any signs of even admitting their shortcomings, far less taking responsibility for them. (Why would they give up their lucrative remuneration if they aren’t forced to?)

2. What cost savings were achieved in putting the measures in place?

a. Were resources actually cut in a net sense?

3. What measures were put in place to test the effectiveness of the AML processes implemented by CBA?

The CBA case study is priceless. If I were to apply for an Australian Financial Services License today and disclosed to ASIC that I had previously been involved in serious financial planning scandals, dubious insurance claims management and utter disregard for Anti Money Laundering requirements, I would not (and should not) be granted a license. Yet CBA and/or its subsidiaries still hold licenses. Go figure.

You invited comment on the Trust Asset at CBA. I don’t trust the organisation and neither does the informed public. CBA have clearly betrayed the trust that any misguided person placed in them.

The tragic truth is that without serious regulatory intervention, nothing will change. A 12 month suspension of CBAs AFSL(s) would be a worthy game changer, but I’m not holding my breath waiting. It is only a matter of time before the next corporate scandal is exposed and those who are responsible will not be held accountable in any meaningful way. They will actually profit from it and my lack of trust will remain well founded.

One final irony – I am a CBA shareholder.

David Smith
Adv Dip FS (FP), SSA. SMSF Specialist Advisor TM, GAICD

Anthony Asher
August 11, 2017

The Austrac court papers are public documents -
Syndicate 1 deposited $20m into 30 CBA accounts, 29 were fake names. Half of this was between April and 1 July 2015 after CBA had identified that they were suspicious. The AFP notified CBA of the problem on 1 July 2015, but CBA allowed the transfer of another $5m before the 24 August.
Was CBA management unaware of the potential implications until AUSTRAC filed on 3 August 2017? What of continuous disclosure?
I doubt that this is the last we have heard of AML. The banks have raised $1 trillion offshore and are far from clear where it comes from. Read
"Most designated non-financial business and profession sectors are not subject to AML/CTF
requirements, and did not demonstrate an adequate understanding of their ML/TF risks or
have measures to mitigate them effectively. This includes real estate agents and lawyers, both
of which have been identified to be of high ML risk in Australia’s National Threat Assessment.
The major reporting entities – including the big four domestic banks which dominate the
financial sector – have a good understanding of their AML/CTF risks and obligations, but
some AML/CTF controls, whilst compliant with Australian obligations, are not in line with
FATF Standards".
My view is the large Australian financial institutions have set themselves unrealistically high ROE targets. CBA is worst. This is consistent with their surprising failure to make any real headway in Asia, and and why they are selling their life insurance arms to foreigners with more realistic targets. It also explains why they have cut layers of management so that there was no-one to take decisive action when they were clearly at risk of assisting criminals. I do think that they need a Royal Commission to do what has been done to shake the churches out of their complacency. They may not be abusing children, but they act as a huge drag on the economy.

August 11, 2017

To me, trust is the invisible glue that binds us in our actions - across family, work, educational, religious and national groups. Built over a long time (sometimes bequeathed to us through inherited behaviour), it is prone to shocks affected by self-interest, greed, wishful thinking or outright fraud humans are capable of. On the other hand, selfless acts inspire trust. Easier to lose trust than gain it.

In financial intermediation (as in medicine, justice, spirituality), the asymmetry of information and grasp between the provider and consumer makes trust crucial. That was why during the GFC otherwise sensible assets lost value and liquidity en masse. The glue was gone.

Disruptions have always inspired awe-struck wonderment at their potential relative to status-quo, but have been invariably affected by those who abuse the trust and naivette of others.

Unfortunately, maintaining trust in normal times is often seen as a thankless task not valued enough - until the next trust-sapping debacle is upon us. In the process affected victims often conflate incompetence with deliberate wrong-doing. Hierarchical power leads to unquestioning obeisance. Have we ever heard of any enterprise glorifying its whistle-blowers as they elevate their business stars?

A sort of 'dynamic provisioning' for the inevitable cyclical trust-deficit is worth pursuing. Easier to do this with money, but how do we apply this say to medicos teachers priests and journos, who abuse the trust of their vulnerable charges?

Garry M
August 11, 2017

The cynic in me says the constant push for a Royal Commission by the ALP is just a legalistic mechanism to force the banks to sell off their superannuation businesses.The Industry Funds will of course be happy to take up the opportunity created,thereby ensuring lots of board seats for the faithful,more donations to the ALP and,when the socialist model that we are heading back to begins to fall apart( as it repeatedly does which ever country you look at),pressures emerge to direct investment flows into "deserving"entities and projects.

August 11, 2017

I'm not so sure trust is really the issue when it comes to CBA or any of the banks.

I suspect apathy, ignorance and inertia are more important factors when it comes to most people's banking arrangements. They either don't care enough, don't pay enough attention or can't be bothered changing, particularly when they don't have any more confidence/trust in the alternatives.

Further, when deposits are explicitly guaranteed by the Government your level of trust in a particular bank is of less importance than your trust in Government to meet their promise.

richard goers
August 11, 2017

My money is on Austrac extracting serious fines from CBA and perhaps ANZ and Westpac
- they have form in TAB $45.000.000 fine for breaches of AML they admitted to
- CBA breaches are worse and they have admitted there were breaches

but in the end, it will be fascinating to watch the regulator v the bank => like the reality TV show 'Billions'
- either party has too much to lose

August 10, 2017

I do not share the view that CBA or the Banks are Australia most hated or distrusted companies. The banks are in most cases better than telecoms and energy companies in terms of trust and making simple commercial arrangement complex to confuse customers. I have never had a telco or an energy company contact me to tell me that I am paying too much because they have just released an better plan but I have experienced banks doing that.

The distrust I have for corporations pales into insignificance when compared to Governments, both Federal and State and the culture that permeates our political ranks.

August 10, 2017

I was surprised at the line about CBA being this country's most hated company. There are so many contenders for this title, i.e.
anyone digging up or using fossil fuels
any electricity supplier

August 10, 2017

Trust is entirely what it's about - it's what enables value and wealth (or lack of it). Haven't had coins in my pocket for years; the few currency notes I carry seem to stay longer in my wallet these days. Most of the financial transactions under my name (including the stock market) are mostly automated. It's as if each individual has a flag hovering over them indicating they have value (or disposable wealth or worth the risk to lend to). Every transaction is based on trust (or is it blind faith?). So as a long term customer of CBA I implicitly indicate my trust in them and the "system". Long may it be so.

August 10, 2017

CBA is plagued by the trifecta of Australia's pet hates right now. The Tall Poppy Syndrome, The "All Banks are Evil" continual media shout-out, and the possible Royal Commission into Banks threat by the ALP.

Their results yesterday were stellar, and in finance circles anyway, have flagged that the "sell the Banks call" by some Banks themselves, some ill informed Brokers and almost all Financial Planners may have been somewhat premature, if not downright foolhardy.

It appears that the Austract Allegation is being taken very seriously by CBA , as well it should. We have only heard from Austract so far, and I am sure CBA will defend this allegation as they have an did in the Cominsure, the out come of which by the way, was never really publicized (They were completely exonerated). They have also acknowledged there were breaches,but the whys, wherefores, and remedies have yet to be revealed.

The haters I saw posting on social media websites yesterday astonished me. None of the "haters" if they are employed would be aware that almost certainly they are shareholders of CBA through their Industry Super Funds. Any disciplined Trustee of a Super Fund would find it difficult not to have the biggest, strongest and most responsible and highest tax paying Company in this Country in their Portfolio. Their Customer Service satisfaction Ratio as presented at the AGM yesterday is extraordinary, to say the least.

75% of that Profit will not line the CBA executives pockets, it will go to the Shareholders in the form of a fully franked dividend. (Yeah! Disclosure obvious I have shares). The other 25% is to buy new businesses, set up new portals, pay all 52,000 odd employees etc etc. Those ignoramuses calling for the imprisonment of Ian Narev, and his Group Executive Team, are uninformed and disgraceful, for these are Honorable Men and Women. I trust them, and will continue to. The AUSTRACT issue will be addressed, until it is, suggesting as some did in the Media yesterday that the fines could be as high at $18 Trillion , if that were to be, it would take down more than Australia's biggest Company, indeed "Prep the Commune", it could bring down the whole Australian Economy.

Surely our continuing aim is to continue to try and keep people informed. I enjoyed your article John Chauvel and Graham Hand. Thank you

August 10, 2017

Is it a case of what is real, and what people want to see. Do people take responsibility for their own choices or look for somebody else to blame.

Have mortgage brokers pulled a good advertising campaign, come to me it will be cheaper and easier, rather than banks ceding.

People never seem to realize that net profit is 1% of gross assets. People see what they want to see.

On one hand non stop crying about huge profits. One second later, too risky to buy shares in it. Nobody will ever be able to explain how owning a company that makes "huge" profits is too "risky".

I've taken CBA to the banking ombudsman before, but I wouldn't have the slightest problem in trusting them.

They will have some bad employees, every company has, doesn't mean the whole company is corrupt.

As Ian Narev said 10 yrs ago an average of 850 shares worth around $47,000 is now worth around $120,000 using the DRP.

If I borrowed $47K from them did the right thing and paid it back slowly, and now have $120K in wealth, why should I or anybody else hate or distrust them for that.

A lot of human nature baffles me.

August 10, 2017

CBA was a government owned oligopoly that was privatised. It had an insufficient culture of accountability or responsibility from the get go. Since privatisation, the executive teams that never built the business or culture have tried to maximise profit which has lead to the financial planner malfeasance, the life insurance debacle and now the money laundering saga. At every turn CBA has tried to dissuade or stonewall light being shed on its shortcomings with respect to compliance and their duty of care to their customer. Only a royal commission in my opinion will right this ship. If it were any other business that was not so integral to the flows of capital for this nation, these acts would have been dealt with well before now.

August 10, 2017

How will a Royal Commission "right the ship"? Are the banks - all of them - essentially corrupt? The outcome of an RC is quite predictable: that banks are well run but need to address problems more urgently (including dismissal of rogue employees) and employee oversight should be enhanced (to reduce the risk of rogue employees. The financial planning issue has already been addressed more generally with laws pertaining to "fee for service" as opposed to commission based remuneration. The suggestion that an RC will "right the ship" goes to the very heart of the matter: it will do no such thing. Its the very proposition that some politicians have pushed without explaining HOW an RC would "right the ship". In fact, Austrac's court case against the CBA demonstrates three things: firstly the effectiveness of the regulators, secondly that, facing a trillion dollars in fines, potential penalties can "break the bank" thereby SINKING the ship - a result an RC could never achieve - and thirdly that running a bank is a very risky business - employee risks, technology/hacking risks, market risks, regulator risks, reputational risks - you name it. If corruption were to emerge from the Austrac case, at the highest levels of CBA in the so called "leadership teams", an RC may then be appropriate to delve into what other corrupt practices may be taking place.

August 10, 2017

Personally, as both a long term customer (35 years) and a shareholder (20 years) I have a very high level of trust in the CBA. They have never really caused a moment of concern to me personally, or my family and friends, in all that time. That's not a bad record is it, or have we just been incredibly lucky?
Even with the recent "scandals" as the media love to say, when you consider the company deals with over 10m customers, and billions of transactions annually, surely there will never be 100% satisfaction for all people, for all of the time. Some of the "disgruntled" Bankwest business client complaints have been nothing but mischievous at best, and looking to blame "someone" for the GFC or their own mistakes. We need to be realistic.
From my reading of the latest AUSTRAC issue, once the problem was realised, CBA actually self reported the 53,000 incidents of non or late reporting, and fixed the software issue within a month - that's not to say it shouldn't have been correct at the outset of course. That was clearly an error.


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