Research published by the banking royal commission has cast doubt on the push by regulators for more professionalism in banking, finding that conflicts should be reduced and not simply managed.

The work casts doubt on the effectiveness of recent calls from the chairmen of the corporate and prudential regulator for bankers to act more like professionals, as a strategy to rebuild trust.

The paper finds advisers are often unaware of biases created by remuneration policies and that a focus on enhanced disclosure and professional ethics may be insufficient to protect customers.

Professor Sunita Sah, from Cornell University in New York, was asked by the inquiry to prepare a paper that was published on Wednesday ahead of the bank CEOs and regulators appearing from November 19.

Rhizome co-founder Tamara Scicluna, with Fahmi Hosain, left, and Will Peterson. She says: "At the end of the day, these ...
Rhizome co-founder Tamara Scicluna, with Fahmi Hosain, left, and Will Peterson. She says: “At the end of the day, these issues are human issues. There is no one cause, just as there is no one solution, no panacea, no end state of perfection.”

Jessica Hromas

It also backs up commissioner Kenneth Hayne’s thinking in the interim report that additional rules may not be the best way to protecting customers.

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The interim report criticised banker greed and questioned whether incentive-based remuneration in banking is necessary at all.

Professor Sah said her research “highlights that strategies to eliminate conflicts are critically important rather than relying on intrinsic values of professionalism and impartiality”.

A leading global expert on conflicts of interest, Professor Sah said many people believe succumbing to a conflict of interest involves the deliberate favouring of self-interest over professionalism, but “in reality, many conflicts of interest that influence advisers occur on a subconscious and unintentional level”.

“While a sense of professionalism may help in protecting against intentional corruption, it cannot reduce unintentional bias that the individual is unaware of committing … Financial advisers’ conflicts of interest are not merely problems for the intentionally corrupt – ie ‘bad apples’ – but also for well-meaning professionals who succumb to unintentional bias.”

Commissioner Kenneth Hayne's interim support questioned questioned whether incentive-based remuneration in banking is ...
Commissioner Kenneth Hayne’s interim support questioned questioned whether incentive-based remuneration in banking is necessary at all.

AAP

‘These issues are human issues’

Tamara Scicluna, the co-founder of consultancy Rhizome, said the new discussion paper “illustrates the complexities that Hayne is being asked to resolve”.

“If we are to be effective, we must develop an ability to enquire into the underlying drivers of behaviour before it occurs and is allowed to cascade into crises. At the end of the day, these issues are human issues. There is no one cause, just as there is no one solution, no panacea, no end state of perfection,” she said.

Professor Sah said any policy responses must be “designed to curb conflicts of interest rather than simply managing them”.

“Disclosure can cause indirect harm if it replaces more effective measures against conflicts of interest and encourages complacency about the inherent problem. Realigning incentives for advisers to eliminate or reduce conflicts of interest will thus have a much larger effect than disclosure in encouraging higher-quality unbiased advice in the marketplace.”

Her research has found disclosure is often ineffective because customers can feel pressured to satisfy their advisers’ personal interests (the “panhandler effect”); and to accept the advice for fear of signalling distrust to an adviser (“insinuation anxiety”). It also has shown advisers aware that clients may seek a second opinion gave even more biased advice; and advisers more easily succumb to conflicts if they are giving advice to multiple recipients.

“It is important for policy-makers to understand that while clarity and salience are important psychological factors in making disclosure more effective, even the clearest and boldest disclosure may fail to protect consumers,” she said.

In its submission to the Hayne interim report, the Australian Prudential Regulation Authority said it agrees a sharper focus on incentive structures is needed, both by regulators and financial institutions. But incentive remuneration still has a role to play, it argued.

“In many institutions, profit targets drive remuneration and other incentives as all remuneration needs to be funded by financial performance if the institution is to be sustainable in the long-term,” APRA said.

“If not balanced by strong risk culture, internal controls and governance structures, however, these incentives can lead to behaviour focused on generating short-term revenue at the expense of long-term sustainability. It can also lead to underinvestment in, and undervaluing of, sustainable processes and systems, including risk management.”

APRA said it “agrees that incentive remuneration can lead to perverse incentives, but it would seem premature to call for abolition of any incentives throughout an organisation”. Unintended consequences included “the conversion of variable costs into fixed costs”.

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