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Big Fines for Banks Don’t Work. We Need Better Punishment

Columns appearing on the service and this webpage represent the views of the authors, not of The University of Texas at Austin.

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Wells Fargo Branch Sign

Wells Fargo continues to make headlines — and not the kind that it wants. Still reeling from the consequences of its appalling sales practices earlier this decade, Wells Fargo agreed in December to pay $575 million to settle claims brought by several states.

Unfortunately, the cycle of bad acts, followed by customer outrage, lawsuits, settlements, and later returning to business as usual is treated as a “wash, rinse and repeat” process for many financial services companies. Indeed, lawsuits, settlements and fines are often viewed as simply a cost of doing business. It shouldn’t be this way.

The 1980s and 1990s witnessed an industrywide transition from “transactional banking” to “relationship banking” and consultative selling. Customer loyalty became an important asset as stock markets assigned higher valuations to banks with more stable revenue streams. The Financial Services Modernization Act of 1999 changed the landscape further, repealing barriers between commercial and investment banking that had existed since the 1930s.

As a result, financial firms rushed to become “one-stop-shop financial supermarkets.” The landmark $76 billion Travelers-Citicorp merger became the poster child for the industry’s march toward bigger, more integrated banks. In banking, size does matter. Banks have tangible economies of scale that yield higher profit margins, while also producing benefits for customers, including better technology, improved product platforms, increased productivity, potentially lower costs, and (at least the perception of) the safety that can come from a better capitalized company.

However, size also carries risks. During the 2008-2009 financial crisis, the U.S. learned important lessons about banks being “too big to fail” — only to see them get even larger and more concentrated in the aftermath. Big banks can incubate even more insidious problems. As these firms get ever larger, some have sacrificed core values in order to keep unsustainable growth rates.

For years, Wells Fargo has made aggressive “cross-selling” activities — a theme begun years ago under former CEO Dick Kovacevich to drive increased revenues per customer — a key part of its business strategy. Cross-selling isn’t inherently bad. It can be useful to have a trusted financial “quarterback” look for opportunities from within the firm’s product offerings to benefit the customer.

That relationship can turn toxic when the incentives are skewed toward encouraging sales over improving the customer’s financial health. The matter worsens and becomes exploitative when bankers employ a “hard sell” of subpar internal products and deceptive sales practices designed to achieve their sales targets.

What is disturbing is that these practices aren’t necessarily limited to just Wells Fargo. In October, American Banker magazine reported that federal regulators found more than 250 “red flags” in a broad examination of more than 40 banks, including the opening of accounts without customer consent.

The banking industry needs to acknowledge that there can be significant disconnects between well-intentioned (hopefully) senior management and branch-level operations. Indeed, during the height of its misbehavior, Wells Fargo had a well-written statement of corporate values. Two of its five values dealt specifically with ethics, trust and “what’s right for the customer.”

Clearly, words were not enough. At Wells Fargo, conflict-ridden compensation plans at the branch level contradicted its own values and contributed to its wrongdoing. Thus, enforcement should include the audit of plans at all levels, and the redesign of those that have the potential for conflict.

Corporate culture begins with a clear “tone at the top” that is consistent and permeates throughout all levels of the organization, is given more than just lip service, and is regularly enforced. From a policy perspective, the banking profession should join the ranks of other trusted advisors, via a regulatory fiduciary rule that formalizes its commitment to seek only the customer’s best interest. For example, such a rule has significantly improved the integrity of registered investment advisers versus their unregulated counterparts.

It’s time for banks to renew their commitment to the spirit of relationship banking by putting the long-term relationship ahead of cutting corners to meet short-term sales goals. Wells Fargo may find that the slightly increased costs of compliance or forgone revenues pale in comparison to the $575 million they just doled out.

S. Michael Sury is a lecturer of finance in the McCombs School of Business at The University of Texas at Austin. Prior to working in academia, he was a nationally top-ranked money manager, supervising several billion dollars in client investment assets, first at Goldman, Sachs & Co. and then for his own firm.

A version of this op-ed appeared in the Dallas Morning News.

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Texas Perspectives is a wire-style service produced by The University of Texas at Austin that is intended to provide media outlets with meaningful and thoughtful opinion columns (op-eds) on a variety of topics and current events. Authors are faculty members and staffers at UT Austin who work with University Communications to craft columns that adhere to journalistic best practices and Associated Press style guidelines. The University of Texas at Austin offers these opinion articles for publication at no charge. Columns appearing on the service and this webpage represent the views of the authors, not of The University of Texas at Austin.

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