Assessing Bank's Proposal From Ethics And Regulation Perspective

For any strategic business proposals, XYZ Bank shall adopt the stakeholder approach to consider the interest of three main stakeholders ie internal, external and connected from both instrumental and normative perspective. Applying Medelow’s stakeholder theory will be helpful in assessing the level of interest, power and predictability of each stakeholders including employees, management & Board of Directors (internal), shareholders, customers & counterparties (connected), as well as regulators & public (external) in terms of economic and ethical impact of each business decision. XYZ Bank is facing a challenge in maintaining its market position and at the same time facing credit quality deterioration for the last 3 years with the difficult operating business environment, hence pressure on its profitability. It is rational for the Board of Directors to exercise their duty of care to drive for reinforcement of management team and giving them the mandate to address the issues with which the society was confronted with.

In formulating the proposal, Ramli and John seem to focus mainly on addressing the interest of most powerful stakeholders ie Board of Director and shareholders from the perspective of instrumental to grow quality assets and maximize the profit. . However, a critical review is needed to exam these proposals impact towards the interest of other stakeholders such as customers (both existing and new), regulator and public especially from the normative perspective to address any potential ethical and philanthropic concerns. Enhancements may be needed to also address these stakeholders’ needs or requirements to provide holistic solutions that create a win-win situation for all stakeholders.

1. The revision to make the mortgage product more attractive by increasing the LTV to 95% can be seen as a defensive measure to maintain its market share in facing increasingly competitive market conditions by compromise prudent and responsible financing practices. From the teleological ethic perspective, though the offer is only targeted salaried applicant with strong income and robust credit history, increasing LTV may cause higher indebtedness of borrowers and compromise their ability to service all their debt obligations. The new team shall exercise deontological ethic reasoning to only allow higher LTV to borrowers with reasonable take home income that sustain their living hood after take into consideration of all the debt obligations. This is also in line with Bank Negara Malaysia’s guideline issued in 2011 on Responsible Financing Guideline, where DSR assessment is required in granting financing. Beside aimed to promote prudent, responsible and transparent retail financing practices, this guideline focuses on consequences-based ethic by emphasis on customer’s sustainability in servicing their debt and duty-based ethic on financial institution’s responsibility to treat customer fairly in offering the financing that meets their requirement with full transparency during sale.
2. Tucker’s approach can be used to assess this arguable proposal. Profitability From a prudent credit perspective, proposal to automatically declined applicant who had applied for a “payday” loan in the last two years will help to eliminate high-risk profile customers and avoid potential high credit losses. Fair However, from the virtue ethical standpoint, the proposal seems to be unfair to this group of applicants by depriving them from accessing to credit without consideration of their financial repayment capability and financing needs Legal The proposal may also not in line with the spirit of Financial Inclusion Framework promoted by BNM under its Financial Sector Blueprint (2011-2020) which vision is “An inclusive financial system that best serves all members of society, including the underserved, to have access to and usage of quality affordable essential financial services to satisfy their needs towards shared prosperity. Right The proposal can be enhanced with additional parameters such as to decline only if the applicant has a bad credit history, high borrowing with lower debt serving ability.
3. The spirit of the proposal to tighten underwriting rules for onboarding self-employed persons and non-incorporated business applicants is in line with the concept of BNM’s Responsible Financing Guideline. Lending to these applicants is always having challenge to assess the financial repayment capability and hence lead to a wrongful extension of bad credit. From the deontological ethical standpoint, it’s the bank fiduciary duty to safeguard the shareholders’ interest and addressing regulatory concern to impose stricter underwriting rules in onboarding these customers. However, the requirement for four years’ financial accounts, drawn up by a qualified, independent accountant appeared to be overly punitive and it will incur massive cost to the applicants relative to their business income. Financial statement of non-incorporated business is exempted being audited by regulation in most countries including UK and Malaysia. Having this requirement will go against the spirit of regulatory exemption with consideration of virtue ethics in providing fair access to credit for small businesses. To address the high-risk nature of these segments, the new team shall consider to propose other form of income proof from these customers. One of the better proof of income will be the income tax receipt, which is readily available verified document from customers. Bank statement of their operating account will be another alternate source of income proof.
4. The remuneration framework of sales personnel can easily lead to mis-selling, hard pressure product pushing if it’s not designed carefully. The infamous US sub-prime lending crisis was a classic case of massive damage being created due to inappropriate remuneration package of sales personnel. According to the report by (Lindley, 2014), “The Federal Reserve found that sales incentives payments based on a loan’s terms or conditions created incentives or loan originators to provide consumers loans with higher interest rates or other less favourable terms, such as prepayment penalties. There was substantial evidence that remuneration based on loan rate or other terms is commonplace throughout the mortgage industry, as reflected in federal agency settlement orders, congressional hearings, studies, and public proceedings”. Regulators including UK FSA has seen recommend banks to implement either claw-back or deferred bonus plan. The proposed remuneration scheme where the rewards are premised upon the performance of the loans for the next three years is definitely in line with regulator’s direction to address the conflict of interest of sales staff. Sales staff will be incentivised to practice the principles of Professional Code of Ethic in closing deal with a higher standard in product transparency and taking more responsibility in product suitability assessment to sustain the performance of loans for longer period and not for short-term gain. From virtue ethic standpoint, staged rewards also help to avoid any potential collusion of sales staff with borrowers to close a deal for short-term gain in the form of commission and terminate the deals post rewards period. However, as cited in the conclusion of (Florian Homann, 2016) paper on “Only time will tell: A theory of deferred compensation and its regulation”, the optimal duration of deferred incentive has to be balance between timing of future reward outcome and the sales personnel liquidity needs. Implementing long compensation period may backfire the bank losing good sales personnel if they have high external job demand.
5. To address high-risk segment, the proposal to impose more stringent lending parameters such as lower LTV to mortgage applications on properties located in severe social stress districts sound reasonable. XYZ Bank is exercising duty-based ethic to society members and regulator to manage the in managing emerging risk the bank faced and lower credit losses. Properties value in districts that facing high unemployment and high crime rates will be subjected to higher downward pressure. Considering the proposal from a consequentialist position, it will help to lower the possibility of mortgage moving into negative equity value where the price of properties goes below loan value. Negative equity will lead to customers facing difficulty to move house or refinancing unless they have cash to settle the shortfall. However, this proposal failed to consider the consequences to external stakeholders especially the public that live in these districts. Tightening single measures without consideration of other measure on customer’s repayment capability will impede residents in this districts’ ability to assess to mortgage loan. Virtue ethic reasoning may highlight the discrimination and unfair treatment against this community, causing bank suffers reputation damage and loss of good customers in these locations.
6. In contrast to previous practice, making credit easier for luxury properties in districts may go against the spirit of duty-based Deontological Ethic that bank is encouraging public to take excessive debt during the stress period. From the perspective of consequences-based ethics, excessive debt may lead to hardship in serving their obligation if they faced financial difficulty in the rising unemployment economy. This is also against the spirit of BNM’s Guideline on Responsible Financing to lend without sustainability assessment of customer’s affordability throughout the course of financing. Offering an attractive deal to existing homeowner to re-mortgage will encourage them to use the cash out money for consumption, rather than income generating activities. Besides facing higher repayment risk by the bank, regulator shall have strong view on excessive borrowing for consumption purpose and increase household debt during economy uncertainty period. In pursue new home insurance business aggressively, XYZ Bank has to be mindful in handling customer mis-selling. In this area, BNM issued a guideline on “Prohibited Business Conduct” on 15 July 2016 to provide non-exhaustive guidance to help banks to understand and comply with the prohibited business conduct spelled out in Schedules 7 of Malaysia FSA 2013. This issuance came after observation of various practices that mislead consumers or putting undue pressure in selling financial products.

For this initiative, for XYZ Bank to achieve results without getting into issue with regulator, it has to provide proper training to the sales staffs to remind them on the mis-use of high-pressure sales technic and should not threaten or misled customer to buy. Taking a more deontological approach looking at duty of care, the sale team need to be educated to treat customer fairly with full transparency in selling process. For this product, sales team has to be taught to identify customer’s needs especially on the insured amount and tenor of the policy that matches their mortgage and financial needs. Clear selling materials especially product disclosure and processes have to be in place to support the aggressive target. The proposal to offer for the bank to pay any switching fees imposed by existing insurers may sound benefiting to new customers to encourage them to switch. However, XYZ Bank is to ensure that the cost of switching the policy are not ultimately passed on to customers through the premium paid, which is in line with the spirit of BNM’s guidance note stated in Part C 8. 5. n of Prohibited Business Conduct on the “Zero entry cost” or “zero moving cost”. The bank also has to address that this action may cause new customers to lose money when they surrender existing mortgage policy. Sales staff has to be reminded to exercise emotional ethic by practicing empathy towards customer loss and not to deceive customers with the gain of 10% discount without netting off the potential loss of surrendering existing policy. From the teleological standpoint, offering favourite treatment of 10% discount on regular premium to new customer may trigger the anger of existing customers. XYZ Bank has been serving the community with high level of trust being created for a long time. Limiting the promotion to only new customer may risk the loss of trust of existing customer. Existing customer may feel that their royalty is not valued and the bank failed to act in good faith to treat them even-handed as compared to new customer. XYZ Bank shall consider giving existing customers other offers in lieu of benefit.

The proposal to outsource recovery function for mortgage accounts in excess of three months in arrears is a major strategic decision that requires detail assessment on its ethical implication to all key stakeholders while observing compliance to various regulations. In Malaysia context, the following regulations key regulations that need to be observed in executing the proposal:

1. Schedule 7 Prohibited Business Conduct, Financial Services Act 2013
2. Section 9, Prohibited Business Conduct issued in November 2016
3. Fair Debt Collection Guideline
4. Division 4 Information and Secrecy & Schedule 11 on Permitted Disclosure, Financial Services Act 2013
5. Outsourcing Guideline, issued in 24 April 2000, with major revision proposed in latest consultative paper issued on 27 September 2017

However, considering debt collection is a job with evil emotion to make debtor pay the debts, ethical consideration shall be the key focus in making decision for bank to outsource it to third party. Various ethic theories such as deontological, teleological, virtue ethics and ethics of emotions shall provide good guidance in this case. The first three registrations stated above also contain good ethical principles in guiding bank in this ethical dilemma situation. With both regulations and ethical principles consideration, the new team can adopt Tucker approach to guide them to make decision:

Profitability

• The remuneration package based on the strength of outsourcing party’s performance in minimizing mortgage losses shall improve the effectiveness of collection and eventually the profitability of the bank, It meets the duty-based ethic in safeguarding the society members’ investment. However, performance-based rewards may intensify the aggressive collection strategy of the outsourced collector and lead to reputation damage and unforeseen financial losses.

Legal

• The greatest risk to outsource collection to specialist credit management company is the potential non-compliance to the regulations stated above. It’s the management’s professional conduct to ensure compliance to extensive rule-based Outsourcing Guideline, adherence to FSA’s secrecy requirements to secure customers’ consent to disclose their information to external debt-collector and due-diligent with continues monitoring of outsourced party’s compliance to above regulations.
• In addition, the outsource collector may not observe their duty to adhere to professional code of practices and violating the requirements spelled out in Fair Debt Collection. Right In the situation where the bank is experiencing increase in mortgage accounts in arrear, to preserve the management’s energy and attention to deal with diminishing business performance challenges, outsourcing of collection of non-performing accounts meets the duty-based reasoning to safeguard the shareholders’ investment. However, from utilitarian standpoint, the aggressive collection practices by external collectors may lead to customer suffers unduly treatment and bank faces reputation damage.

Fair

• Treating customer fairly shall be the biggest deliberation in this decision process. In deontological reasoning, the new team may need to examine the code of practices employed by the external collectors in executing their duty of care towards bank’s debtors. Lack of care and without proper utilitarian reasoning by the collectors, the customers may be treated unfairly from the undue pressure and harassment during collection process and worst, the violent act that lead to injury. Any incidents of abusive collection with no ethical emotion act towards customer will definitely damage the trust of customers or even public to the Bank, and eventually loss of business. Proper Service Level Agreement with clear penalty clause needs to be set for the credit management company to adhere to the professional code of practice in their debt collection activities.

Sustainability

• Another aspect that the bank needs to assess is on the sustainability of this outsource business model. From the utilitarian consideration, the new team shall address the excess resources in the existing collection function post outsource arrangement. Lay-off may not be a popular option during this stress period from both reputation risk as well as virtue ethics standpoint. of The bank may consider other alternatives to maintain employment of these excess staff to either re-deploy them to other functions or making arrangement with the specialist credit management company to absorb them.

The two new management members are higher recommended to work with the internal control functions such as Risk Management and Compliance to assist them to review the proposals to ensure compliance to various regulatory guideline to avoid unnecessary non-compliance incidences. In conclusion, XYZ Bank shall perform detail assessment to re-exam its proposals to consider the impact to other stakeholders especially customers and public as a whole. Good proposals shall not just be addressing internal needs to meet profitability target. Unfavourable measures that potentially lead to mistreating of customers will have long-term negative impact to bank’s profitability due to loss of customers. It may also lead to the loss of public trust, where the bank may be seen as taking measures against public interest during bad time instead of maintaining favourable policy to walk them through the hardship. Trustworthiness is the most valuable intangible assets of a bank like XYZ Bank that serve the community for long time. Losing it may eventually threaten the long-term business sustainability of business.