Seller beware

Conduct risk, which places emphasis on providers of credit to treat customers fairly, will challenge them to deliver higher standards of customer support across the whole relationship, says Jonathan Westley of Experian’s Consumer Information Services.

Lenders will face tough new standards for customer interaction from 1 April 2013, which will materially impact customer sales and relationships in financial services. The UK’s new financial services regulator the Financial Conduct Authority, will begin to apply measures to reduce ‘conduct risk’, a new category that encompasses any factors that could undermine the regulator’s mandate to protect consumers.

Several elements of this concept are already being dealt with by banks as part of other disciplines, such as the Know Your Customer regulations; operational risk; and the Treating Customers Fairly initiative. Bringing them together under one umbrella will require firms to take a more active role in creating “a stable, customer-focused banking system that can regain public trust”, said the British Bankers Association.

The FCA was established in response to issues of conduct within the Financial Services sector and will apply a new approach with its single objective of protecting and enhancing confidence in the UK financial system, including an appropriate degree of protection for consumers.  The miss-selling of derivatives is an example of the conduct that the FCA will seek to quash.

To deal with conduct risk, the agency noted 15 categories that it considers will require a “firm and regulatory focus” over the next 18 months. They reach across different aspects of consumer finance and take in cultural, operational and procedural elements including compensation, product bundling and complexity and “aligning business models to fair treatment of consumers.”

There is a reputational risk. The FCA will be able to publicly announce that it has begun formal disciplinary proceedings against a firm or individual by publishing details of a ‘warning notice’ if it considers it appropriate.  The ‘warning notice’ will be published at an early stage of investigation, before the firm has had the opportunity to put its case before the Regulatory Decisions Committee.

The FSA’s model of only publicising investigations that have been concluded will no longer exist. By publicising enforcement action, the FCA aims to improve transparency about its enforcement processes. It will also have the ability to intervene on products prior to their sale and ahead of concerns being raised by third parties. That makes it imperative for regulated firms to protect themselves from such actions and get checks in place for both established products and new product sales, in a way that doesn’t disrupt the customer experience.

For the front office, checks and risk management processes will increase significantly, to avoid a repeat of the circumstances surrounding recent miss-selling events. There is also a need to ensure that the product creation process is attuned to the new regulatory environment, so new developments must have the appropriate characteristics.

The opportunity exists to develop a system based on customer data, enabling providers to predict requirements and change in personal circumstance, and create stronger relationships with customers, whilst providing the best possible service.  There are three strands to this:

Sales will require a detailed KYC exercise, to avoid the potential for miss-selling.  Not just a fraud / anti money laundering KYC check but a full Know Your Customer check;

– The online marketing of products will have to be managed carefully, with the right rules applied to each customer;

– The lender must ensure the on-going suitability of products for consumers, even as circumstances and products change.

– Getting tough with the sales process could make interaction on high volume product lines slower and more expensive. Managing existing relationships more closely will necessitate greater administration.

Clearly authorities are not trying to reduce the scope of products available to the retail customer, but recent experience of miss-selling suggests that lenders will have to think more carefully about applying greater rigor to client interactions if they are to maintain revenues from current lines of business.

The challenge then, is to develop a system that will minimise the cost of compliance, providing certainty for the bank, with processes that can be easily integrated into the existing sales and client management process.

The technical challenge is to deliver an integrated management information picture from relevant and verified data, sourced internally and externally. Integrating that data into a useful profile of the customer will not only support the firm in mitigating conduct risk, but also support customer relationship management initiatives and anti-fraud.

The way forward is a system that encapsulates the financial sophistication, risk attitude and affordability of a consumer or business into a series of indexes. Used together with product eligibility rules, it could allow initial product suitability assessment prior to processing with the product application process.  It comes down to use of information at the point of interaction.

By taking the approach used for credit rating and identity verification purposes, lenders could take an automated, score-based view of customers’ suitability for services/products. Suitability is likely to be measured in terms of their affordability, the customer’s attitude to risk for savings or insurance products, their financial sophistication and a more detailed understanding of their circumstances in the same terms as KYC.  All of which needs regular reviews for changed circumstances, which the lender will be required to act on.

This could lead to an automated capability that is used to ensure that products are always aligned with a customer’s needs even when their circumstances change. It could satisfy the requirements for conduct risk whilst providing the best experience for the customer as they proceed through the sales process.

The same approach could be applied to existing customer management processes providing a continuous re-evaluation of on-going product suitability and allowing an organisation to quickly take corrective action when a customer’s circumstances change.