Incentives and compensation: top 10 operational risks for 2013 In 2011, UK banks ring-fenced a total of £5 billion for expected compensation payments to customers who had been mis-sold financial protection products, in particular payment protection insurance (PPI). In 2012, it emerged that they had been too optimistic – the major banks have more than doubled their provisions for PPI payouts. Barclays alone has now set aside £2 billion for PPI payouts; Lloyds added another £1 billion in its Q3 results in November; other banks have followed suit, bringing the total provision close to £10 billion at the time of writing, roughly 70% of which has already been paid out. Nor is there any sign of an end. The UK’s Financial Ombudsman Service (FOS) handled 157,712 complaints about PPI in the year to April 2012. By the end of October that year it had already received another 99,174 new PPI complaints – 50% higher than it expected. At this point, it doesn’t take much foresight to conclude that mis-selling will continue to be a major concern – at least for UK banks – in 2013. The banks’ own incompetence in handling the claims will make it worse. Natalie Ceeney, chief executive of the FOS, told Parliament that in a quarter of cases, banks had falsely told customers that they did not have PPI policies. And, the FOS said, mis-selling goes beyond PPI – it is also seeing a new wave of mis-selling complaints surrounding interest rate swaps sold to small businesses. The UK Financial Services Authority (FSA) has blamed poorly designed and perverse incentive schemes across the industry. A consultation paper released in late 2012 pointed the finger at a combination of high-risk, high-reward incentive schemes with a lack of effective oversight, citing Lloyds in particular as failing in this regard. Martin Wheatley, the FSA managing director who will head the Financial Conduct Authority (FCA) from its inception in 2013, said in September 2012: “This bonus-based approach has played a role in many scandals we have seen over the years. Incentive schemes on PPI were rotten to the core and made a bad problem worse.” Final rules will not come into force until early 2014 – and Wheatley has called on banks to “clean up their act” before that date. But the incentive issue is likely to produce salient operational risks in several areas in 2013. Most obviously, banks – and other financial institutions, to a lesser degree – will face further mis-selling payouts to their customers, keeping the issue in the news and causing further reputational damage on top of the financial cost, which at present is significant but not crippling. But switching to new incentive schemes also carries risks: banks may lose their best sales staff to rivals which offer schemes viewed as superior; a new scheme brought in before the deadline may later fall foul of regulators, and avoiding this will require close co-ordination with the FCA; and, most importantly, banks will have to ensure that the new scheme is not as easy to game and as likely to produce undesirable results as the one it replaced. Top 10 operational risks 2013: Back to introduction IT sabotage Reputational damage Incentives and compensation NEXT: Fraud and customer data abuse Epidemic disease Political intervention Sanctions and AML compliance Emerging market operating risks Business continuity and disaster recovery Failure to enforce internal controls...
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