The top 10 retail banking scandals: 60 billion reasons why shareholders must play a greater role in changing bank culture

In November 2014, New City Agenda published the first comprehensive study into the efforts that retail banks were undertaking to change their culture. It was clear that the banks sales-based culture had cost their shareholders dearly and that investors needed to do more to support the process of cultural change in the UK’s banks. The report found that between 2000 and November 2014 UK retail banks and building societies had set aside over £38.5 billion to pay compensation to customers. This meant that £1 in every £4 of pre-tax profits earned by the banks had been paid out in redress and associated administrative costs.

The 2014, 2015 and 2016 results brought a wave of additional provisions for Payment Protection Insurance, investment product and packaged bank account mis-selling and breaches of the Consumer Credit Act. Two and a half years later the total costs have increased to over £60 billion. The profitability of UK retail banks has been imperilled by persistent misconduct and an aggressive sales based culture. This has made every citizen poorer through our pension funds and our ownership of the bailed out banks.

The scandals covered a wide range of products and practice. But key root causes of these issues include poor quality products, inappropriate staff bonus schemes and an aggressive sales-based culture.

PPI scandal cost more than 4 times London 2012 Olympics

These figures indicate the sheer scale of the cost of the sales-based culture, for both banks and their shareholders. Total amounts set aside for PPI redress now stand at £43.5 billion – around 4.5 times the cost of the London 2012 Olympics. Banks have proved hopeless at estimating the total cost of their misconduct – with some increasing their PPI redress provisions 10 times over the past 3 years. Legitimate complaints have been rejected and banks have delayed writing to customers, meaning that the scandal has taken years to be resolved and cost billions in administrative costs.

Significant impact on shareholders, but high bonuses continue to be paid

Misconduct costs in retail banks have had a devastating impact on their profitability and the dividends received by shareholders. Between 2010 and 2014 only HSBC and Santander have paid out more in dividends than in retail misconduct costs.

  • At Lloyds, retail misconduct costs have amounted to a staggering £14 billion, compared to dividends of just £500 million.
  • RBS has not paid a penny in dividends to its shareholders, but has had to find £6.4 billion in misconduct costs and has chosen to pay £3.8 billion in bonuses.
  • If Barclays had managed to restrain its misconduct costs then it could have tripled its dividend.

Despite the significant retail misconduct costs incurred plus further penalties for LIBOR and foreign exchange rigging, bonus payments have remained high – totalling £31.5 billion between 2010 and 2014.

Bonuses, dividends and retail banking misconduct costs – 2010-2014 (£ billion)

Bank

Bonuses

Dividends

Retail Banking Misconduct costs

Lloyds

2.15

0.5

14.0

Barclays

12.5

3.8

7.3

RBS

3.8

0

6.4

HSBC

12.3

25.7

3.9

Santander UK

0.7

2.5

1.2

Total

32.6

31.5

32.9

Notes: Bonuses and dividends at Lloyds, RBS, Barclays and HSBC are for the full banking groups. Retail Banking Misconduct costs include all misconduct occurring in the UK retail bank of the relevant banks.

Corporation tax changes

In the future amounts set aside by banks will have greater impact on their bottom line. Budget 2015 announced that the Government would stop banks from using the costs of compensation to offset or reduce the amount of corporation tax they owe. This change has already raised far more in the second half of 2015 than expected by HM Treasury.

Action needed from banks and shareholders

Banks needs to provide shareholders with clearer visibility on what issues are covered by the provisions and what skeletons remain in their cupboards. Banks continue to list provisions in the hundreds of millions of pounds as “other” redress with little detail about the issues covered or how the provisions have been calculated.

For their part, shareholders don’t seem to be asking the right questions about how these costs are calculated and whether banks’ culture change programmes will be successful in stemming the tide of misconduct provisions.

This could reflect an attitude amongst shareholders that the scandals are all “historic”. Whilst this may be the case for some issues, shareholders should play a far greater role in ensuring that once problems are discovered, they are confronted and addressed quickly and consumers receive fair redress. We know that banks have been forced to reassess over 2 million PPI complaints which were initially rejected unfairly – adding billions of pounds in administration costs and extra redress.

Change culture to improve profits

Excluding the misconduct costs, the major retail banks would be robustly profitable. This makes it even more important for shareholders to engage and monitor the progress made by the banks in changing their cultures. Shareholders should be championing initiatives to raise professional standards and change culture, demanding clearer information on how misconduct provisions are calculated and ensuring that remuneration schemes at all banks reward positive changes in culture. To ensure that they hold senior executives accountable, shareholders must demand transparent assessments of progress for each individual bank.

Shareholders should also ensure that bonuses are related to real levels of profit, rather than some “adjusted” or “underlying” measure which excludes misconduct costs. The coming bonus round will also be a key test for shareholders and regulators as to whether they insist on significant clawback of bonuses from any executives presiding over misconduct.

Top 10 financial scandals in UK retail banking

Type of Misconduct Provisions (£ billion) Years provisions were incurred
PPI Mis-selling 43.5 2010-2016
Interest Rate Hedging Products Mis-selling 4.8 2012-2015
Endowment Mortgages Mis-selling 1.9 2002-2006
Mortgages 1.2 2002-2016
Packaged Bank Account Mis-selling 1.1 2014-2016
Consumer Credit Act Breaches 1.0 2013-2015
Investment Products and Advice Mis-selling 0.9 2003-2015
Pensions Mis-selling 0.6 2000-2002
Unfair unauthorised overdraft charges 0.6 2006-2007
ID theft and Card Protection Insurance Mis-selling 0.5 2014-2015
Other issues / Miscellaneous 5.0 2000-2016
Total 60.5 2000-2016

1. Payment Protection Insurance – £43.5 billion

PPI was insurance sold alongside unsecured loans, credit cards and mortgages. It was widely mis-sold to consumers unable to claim on it or not even realising that they had bought the insurance in the first place. Between 1996 and 2012 banks sold over £44 billion of PPI. Warnings from consumer groups and politicians were ignored and banks challenged regulations put in place by the FSA and the Competition Commission. Enforcement action taken by the FSA fined banks only a tiny proportion of the revenue they made from selling PPI. Banks selling PPI received very rates of commission – as much as 87% of the premiums paid by the consumer, so a bank selling a PPI policy costing £10,000 would receive £8,700 in commission. PPI was a very profitable product, accounting for over a third of retail banking profits in the years it was sold.  The cost of the PPI scandal will continue to increase as banks set aside more money to cover redress following a judgment in the Plevin case regarding the impact of failing to disclose the high commission rates to consumers. The FCA is introducing guidance on this issue as well as proposing to introduce a deadline which will prevent any consumers submitting complaints about PPI after August 2019, although over 5.5 million consumers will have an earlier deadline to complain about PPI mis-selling as they have 3 years from the date on which they were sent a letter from their bank.

Cost of PPI scandal – Top 10 banks

Bank Cost of PPI scandal
Lloyds banking group £18.2 billion
Barclays £9.3 billion
RBS £5.0 billion
HSBC £3.4 billion
Yorkshire bank / Clydesdale £1.8 billion
Bank of America (MBNA) £1.5 billion
Santander £1.5 billion
Citibank (Egg) £0.7 billion
Co-operative bank £0.5 billion
Northern Rock / UKAR £0.5 billion
Other £1.1 billion
Total £43.5 billion

2. Interest Rate Hedging Products – £4.8 billion

Alongside loans to SMEs banks sold Interest-Rate Hedging Products – known as Swaps – to SMEs which were designed to protect SMEs against rising interest rates. The FSA found a range of poor practice including failure to assess attitude to risk or explain exit costs. It was also reported that SMEs were told that they risked being refused credit unless they bought a Swap. In 2012 a redress programme was introduced and banks have now settled the overwhelming majority of claims under this scheme. However, a number of SMEs and the Treasury Select Committee have expressed concern about the operation of the scheme.

3. Endowment Mortgages – £1.9 billion

An endowment mortgage was an investment product sold alongside an interest-only mortgage which was intended to provide a lump-sum to repay the mortgage at the end of the 25 year term. Risks were not properly explained to consumers and when mortgages began to mature many consumers found that there was a shortfall between the amount they owed and the return on the investment.

4. Mortgages – £1.2 billion

The vast majority of this cost represents the cost of redress for Halifax when it was found to have misled consumers about the application of a “Cap” to their mortgage Standard Variable Rate. Other mortgage misconduct includes refunds for excessive mortgage arrears charges and exit fees and compensation banks were required to pay for keeping some customers on higher SVRs.

5. Packaged Bank Accounts – £1.1 billion

These accounts provided a package of additional services such as travel insurance, discounts and in return for a monthly fee. Banks automatically upgraded some consumers to these accounts and failed to get proper consent. Staff could receive higher bonuses for pushing these accounts rather than normal no-fee current accounts. Outside of PPI, this is the fastest growing scandal with all of the £920 million in specific provisions being made in the last year and a half.

6. Consumer Credit Act breaches – £1 billion

By not complying with the technical details of the Consumer Credit Act banks have had to refund interest charged to customers. These breaches include failures to comply with requirements to provide post-contractual information in statements and arrears notices.

7. Investment products and advice – £880 million

Banks failed to properly assess a consumer’s attitude to risk or capacity to withstand investment losses. Commission-based advisers in the banks pushed consumers into poor quality or risky investment products. Complex structured products were sold which under-played the risks or exaggerated the potential returns.

8. Pensions – £600 million

People who would have been better off remaining in their employer’s pension were advised to transfer out or stop contributing and join a personal pension. By 1992 it became apparent that many people had lost out and a review was launched. After 2000, some banks were still making provisions for the cost of their mis-selling.

9. Unfair Bank Charges – £560 million

Banks charged very high amounts when customers exceeded their overdrafts or had a payment rejected. Consumers challenged these charges as unlawful and excessive. A significant number of complaints were upheld before the banks and the Office of Fair Trading agreed to a test case to determine the fairness of the charges. The banks won this test case which meant that they could reject virtually all of the complaints still outstanding.

10. ID theft and Card Protection Insurance – £450 million

When consumers phoned up to activate their debit or credit card they were given the hard-sell for ID theft insurance or Card Protection Insurance. These were supposed to pay-out if consumers had their identity stolen or a fraudster accessed their account. However, consumers were already protected against fraudulent transaction on their account. Those selling the insurance mis-led consumers about the prospects of having their ID stolen and the existing protection available to them. Only a tiny proportion of the cost of the product went to pay for the insurance with the remainder accounted for by a commission split between the seller of the insurance and the bank which funnelled the customer to the insurance company. A redress scheme was established by the FCA but only 34% of consumers responded.

Miscellaneous issues

In addition to the Top 10 issues identified the UK’s retail banks paid £4.9 billion of redress for a wide range of other scandals including mistreatment of SMEs in financial difficulty, technological breakdowns, weaknesses in complaints handling, excessive charges for foreign exchange, mis-selling insurance products and anti-money laundering failings. Banks also listed hundreds of millions of pounds as costs described as “Other” or “Miscellaneous” redress without giving further details about precisely what products were covered.