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Will the Royal Commission ban all incentives? Not quite

The Financial Services Royal Commission continued its Round 4 hearings in Darwin this week, with a focus on the rural sector, especially agricultural lending. It followed a now-familiar pattern. Case studies were identified by the Commission, usually self-reported by banks as part of the discovery process, and aggrieved bank customers appeared as witnesses unloading about their mistreatment. Then a middle-ranking bank executive apologised for poor behaviour under intense questioning.

Banks are defending their positions poorly

The banks are a big target and the Royal Commission has plenty of arrows in its quiver. There is no doubt much bank behaviour identified has been inappropriate. It’s also true the Commissioner has to push hard to meet his deadlines. As the Chief Executive Partner of King & Wood Mallesons (KWM is doing the AMP work), Berkeley Cox, told The Australian Financial Review:

"The Commission has got a timetable and for the Commissioner to meet that timetable – given the terms of reference – there's a lot of work. It's a difficult task for the Commissioner. It's a difficult task for the AGs [the Attorney-General's Department]. It's a difficult task for the clients, so it's a difficult task for us. That's the way it is."

Another unidentified lawyer told the AFR that “Somebody is going to die” due to the intense legal workload involved in 18-hour days, seven days a week.

A surprising aspect of the interviews is that the bank executives are defending their policies so poorly, or not at all. The Counsels assisting the Commission have a powerful position, but the bank executives are experienced professionals on large salaries. Many of them appear like deers caught in car headlights. The policies represent the way the banks offer their products and services. Across a wide range of products, such as mortgage lending, financial advice, funds management and farm loans, the bank policies were developed and agreed after considerable debate and research across the business. Yet there is relatively little explaining and defending the products, and nobody is willing to tell the ultimate truth: “We do it this way to make more money.”

Incentives are an important part of businesses

Almost every major business has bonus incentive schemes for staff. They are a valuable way of rewarding effort, and they have been a fundamental part of KPIs for decades. Of course, they must be structured properly with risk and reward, and not provide the wrong incentives. The Royal Commission is rightly drilling into when incentives cause the wrong behaviours, such as falsifying documents to increase loan sizes, or giving advice that generates the maximum commissions.

But the continuous line of questioning from the Commission over the months seems to target all incentives as unacceptable. The crucial point is to design them correctly, not ban them.

So it was refreshing this week to hear Bradley James (BJ), Rabobank’s Regional Manager, Southern Queensland and Northern NSW, firmly defend his bank’s policy and not duck the issue under examination from QC and Commission Counsel, Rowena Orr (RO). Ms Orr had earlier interviewed an aggrieved Rabobank client, Mrs Bauer, with leading questions such as “What is the non-financial impact of all this?” and “How do you feel about your experience with Rabobank?” Mr James was in the room listening to the fierce criticisms of his bank and he could easily have cowered under interrogation.

RO: Does Rabobank still set KPIs for its bank managers that have lending targets?

BJ: Yes, we do.

RO: And why do you do that?

BJ: To enable us to grow our business through increased lending.

RO: Do you see any difficulties with that from a customer perspective, Mr James?

BJ: Absolutely not.

RO: No difficulties?

BJ: None whatsoever.

RO: Do you see any difficulties having heard the evidence of Mrs Brauer about her experience?

BJ: I do understand the difficulties that Mr and Mrs Brauer experienced as a result of how those actions may have come about, but in terms of us having objectives for managers to lend to increase the business, I have absolutely no problems with that whatsoever.

RO: So does Rabobank take some responsibility for creating a system that incentivises its bank managers to go out and sell as much volume of loans as they can so that they can meet their KPIs?

BJ: If it was unqualified, I would have a problem but it’s not unqualified.

RO: In what way is it qualified, Mr James?

BJ: We have a requirement for our managers to lend sustainably in terms of the risk in those KPIs as well.

RO: Mr James, what’s the consequence of meeting your KPIs?

BJ: The consequence of meeting them? So we have – at that stage we had a – what I would refer to and the bank refers to as a discretionary bonus system. In line with a review of salary, what we refer to as TEC (Total Employment Cost), and that alignment of that salary is in terms also of the performance of a staff member, not just a manager.

RO: So if you met your KPIs you were eligible for a bonus?

BJ: That’s correct.

RO: And if you didn’t meet these lending targets, you wouldn’t be eligible for your bonus?

BJ: If you didn’t – well, no, it’s not just the lending targets. So if you met the lending targets and you didn’t meet the risk aspect of it, you may not achieve a lending target. Because it’s – it’s assessed as a total contribution.

RO: But one element that you had to satisfy was meeting your lending targets. Is that right?

BJ: Yes, that’s correct.

RO: If you didn’t meet your lending targets, it didn’t matter about the rest of it, you wouldn’t be eligible for a bonus?

BJ: No, that’s not correct.

RO: Okay. Could you explain that?

BJ: Because it’s discretionary, we look at the seasonal conditions that may exist at the time. So in any given year we’ve had managers that have achieved a bonus who haven’t met their lending targets because of circumstances beyond their control. It is rare that we would pay – and in my personal experience would not pay a bonus to a manager who has achieved those lending targets but did not achieve the risk targets.

Good to see a bank executive stand up for a policy he believes in.

(For further context, see https://financialservices.royalcommission.gov.au/public-hearings/Documents/transcripts-2018/transcript-27-june-2018.pdf)

A typical tough day at the Royal Commission

Here is another insightful exchange between the Commission and Charles Scerri (CS), QC for BankWest and CBA at the end of an intense day.

CS: Commissioner, can I respectfully ask how much extra time we need? The difficulty is that Ms Taylor comes from Perth. She has a young family. She has been involved in this for weeks now. And if it’s possible to finish tonight, we would very much appreciate it. We have been told several times that it’s expected that she would finish tonight.

COMMISSIONER: I’m surprised by that, Mr Scerri, but there we are. What do you say, Ms Orr?

RO: I think I’ve got up to an hour, Commissioner.

COMMISSIONER: Well, I’m not sitting that long.

CS: No, I understand.

COMMISSIONER: Mr Scerri. It’s not fair to the witness.

CS: No. I was really trying to clarify whether it was 10 minutes or an hour or two hours.


CS: Some of the estimates have been pretty inaccurate, I should say, with respect, sir.

COMMISSIONER: Mr Scerri, do you want to think about that statement again?

CS: Yes. It is the fact, sir, that witnesses have cooperated to extraordinary extents, and the estimates of when they will be required and where has changed a lot.

COMMISSIONER: I have noted what you’ve said, Mr Scerri. It may surprise you then to know that very careful attention is given to trying as best we can to minimise disruption. Now, do we always succeed? No, we don’t. I accept that. I know we don’t always succeed. But we do try.

And then the Commission adjourned for the evening. There’s no doubt it’s tough in that room, but it would be good to see a few more of the bank executives who actually designed and approved the policies at Executive Committee level come in and explain the bank’s culture and decisions.

But rewards and incentives are appropriate for some

While the Commission zeros in on any incentives in financial services, there’s one group of people for which they are entirely appropriate. Going back to Mr Cox of lawyers, KWM, he said his firm is rotating staff and working on their wellbeing, including "very deliberate reward and recognition – financial and soft benefits". Of course, why not give incentives and rewards for a job well done.


Graham Hand is Managing Editor of Cuffelinks.


Incentives at heart of Commission's findings

The spirit of the game applies to business, too



July 06, 2018


First, I am really enjoying your reporting of the royal commission – please keep going. Also, you were early onto the importance of this – congratulations on that. I predict that ‘royal commission’ will become part of the industry lexicon, just as GFC did.

Second, you will have to go some to get me away from my prior view that fixed pay is the only correct incentive structure. If people want to get rich quicker than that, then we have an existing technology – equity – that they can buy, post-tax, from their fixed pay.

As for Rabobank’s lending growth KPI it is clearly wrong. Debt should be bought, not sold – ie if Mrs Miggins sees debt as the most appropriate way to achieve her life goals then she should initiate the lending process. This is because debt carries irreversible risk for the individual (as well as opportunity). So better metrics for a branch / manager would be to grow market share provided that the total indebtedness of that town / community did not grow in real terms. That would be socially aligned!!

A recent Martin Wolf column in the FT discussed an Adair Turner lecture – one of the key points is the fundamental difference between value creating activities and zero-sum, or value distributing activities. We in the financial services industry like to think we create value, whereas the bulk of activity is about re-distributing value.

That is the underlying problem with incentive structures – and I would argue the underlying (if unverbalised) issue of the royal commission.


Phil K

July 06, 2018

I suspect the banks are deliberately adopting a "path of least resistance" approach to minimise public backlash and regulatory overkill. Unfortunately, that's the way of things these days - confess to everything and apologise profusely to keep the howling mob at bay, regardless of innocence or guilt.

Even if they had a good case for their defence (which they would in many instances, but certainly not all), it's probably not worth the risk. However, I do admire the efforts of the Rabobank manager you quoted above.

I agree that the last thing we want is to ban incentives altogether. It would be bad for everyone (customers included) if banks ended up like, say, the teaching profession where the brilliant teachers and the barely literate ones get paid the same.

Where all these incentive/remuneration schemes fall down is their insistence on having quantitative measure of success. Very few jobs lend themselves to purely quantitative performance measurement, yet we pretend otherwise. And this is because we know we can manipulate quantitative measures by focusing on the metric itself rather than what the metric is supposed to be measuring. In my career (I use the term somewhat loosely), whenever I suggested we evaluate performance more qualitatively (eg get the opinion of peers), it only provoked looks of horror.

I once had a 4-page document that precisely defined everything I had to do (or not do) in order to get each of 5 possible scores across a range of about 12 KPIs. It was the funniest official document I ever saw. That's the sort of thing that needs banning. As an alternative, a quick check with my peers and internal customers at year-end to see if I'd been useful or a waste of space would have been more accurate, saved a lot of time and would not have encouraged any perverse behaviours on my part. Problem solved.


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