Consumer Distrust in the UK Financial Services Industry - Essay Example

Financial Regulation, Law and Compliance By Introduction The UK government was forced to intervene and provide public funds to recapitalise some struggling lenders in an effort to manage the pressures of the global financial crisis 2008-09. The public funds used to save banking industry (or the bailout money) represented an equivalent to £2,000 for every person in UK. It was one of the major reasons that have marred consumer perception of the UK financial services industry, leading to a breakdown of trust. This paper will explore more factors that have contributed to consumer distrust in the UK financial services sector. The paper will also discuss why trust is considered inevitable in the financial services industry. Finally, different methods that have been put in place/are proposed to restore trust will be evaluated. Consumer distrust in UK financial services industry A healthy financial system is an integral part of a healthy economy as it helps the business sector to invest and grow; to deal with daily transactions and manage risks; and to underpin activities in every segment of the society. According to the Confederation of British Industry, the UK’s premier business lobbying organisation, the UK financial services industry plays a significant role in enhancing the country’s business growth and overall economic development (PWC, 2012). The products and services offered by this industry represent a crucial part of the UK economy and constitute one of the country’s few world-class sectors. A well performing financial services sector is very important in the modern economy to develop a competitive and resilient financial system which is free from taxpayer support and is co-ordinated globally (Ibid). The UK financial services industry employed nearly 1.2 million people in the 3rd quarter of 2012, representing approximately 4 percent of the UK workforce. In the financial year ending 31st March 2012, the industry paid and estimated £63bn in taxes, accounting for around 11.6% of the total government tax receipts in UK (Ibid). Despite the crucial role that the UK financial services industry plays in the growth of the country’ economy, consumer trust and confidence in the UK financial services industry is very low currently (BBC News, 2014). According to an annual survey conducted by the public relations firm Edelman, “less than half of the public trust banks do what is right, making financial services the world’s least-trusted industry for the second year in a row” (The financial brand, 2014). Since the global financial crisis 2008-09, the consumers’ trust and confidence in the banks’ ability to do right things have dropped by a shocking 30% in the UK (Ibid). The following figure depicts this fall in consumer trust. (Source: The Financial Brand, March 20, 2012) According to PwC’s latest report (2012), currently fewer than one in three customers trust their bank although most of them still do not want to switch to other banks. In addition, nearly 57 percent of customers believe that current regulatory reforms are not adequate enough to make sure that the history would not repeat (Ibid). The report says that the term apathy can best represent the UK customers’ feelings toward the financial services sector. The following figure illustrates UK’s poor global position in terms of the consumer trust in the financial services industry. (Source: The Financial Brand, March 20, 2012) Factors led to the breakdown of trust While analysing the major factors that have marred consumer perception of the UK financial services industry and led to a breakdown of trust, it seems that the global financial crisis 2008-09 played a crucial role. The global financial crisis has had dreadful impacts on the UK economy, particularly on the financial services industry comprising of banks, insurers, fund managers and other financial services providers. In September 2007, rumours spread that the Newcastle-based bank Northern Rock was struggling from severe financial difficulties (IHRR Admin, 2013). The depositors became panic as these rumours gained some credibility, and hence they rushed to the bank’s branches to withdraw their savings on the fear that they would lose their money in the event of the bank failure (Ibid). The Northern Rock had adopted a business model that relied on short-term credits from other banks to meet its short-term financial needs. Unfortunately, banks stopped lending to fellow banks in the wake of the sub-prime lending crisis in the United States, citing possible financial losses in case of a default in repayment. This situation created huge troubles for the Northern Rock and it had no alternative but to seek financial assistance from the Bank of England, the lender of the last resort. While negotiation of the required assistance was going on, further rumours began to circulate that the bank was undergoing bankruptcy. In order to prevent the possible spread of the panic depositors’ actions to other British banks, the UK government was forced to guarantee the bank deposits. In addition, the near collapse of two Scottish banks, RBS and HBOS, also forced the government to guarantee massive intervention to save depositors’ money (Ibid). The real problem was that the RBS had acquired one of the England’s largest banks NatWest, which was placed at the heart of the UK’s short term lending and occupied a crucial position in the country’s payments system (Ibid)). Hence, the near collapse of RBS caused to significantly drop consumer trust and confidence in the UK financial services industry. To worsen the situation, the US based Lehman Brothers collapsed in September 2008. At the time of its failure, Lehman Brother was the world’s one of the largest investments banks and it had a complex web of interconnections across the globe. As a result of the banking sector sluggishness, UK suffered an output loss of 24% (Ibid). Similarly, many other banks in the UK were facing collapse in the context of the global financial crisis 2008-09. The UK banking sector adopted a range of policies, many of which were unappealing to depositors, in an attempt to survive the crisis. An unfair sales and bonus culture, bailouts, interest rate manipulation, lack of accountability, and poor access to banking services were some other key factors that ruined consumer trust in the UK financial services industry (Lecture 4, slide 3). An unfair sales culture characterised with mis-selling of pensions, endowment policies, and credit cards negatively affected the consumer perception of the industry (Lecture 4, slides 4-6). Mis-selling of PPI, an insurance product offered to borrowers to protect their credit payment capacity in the event of accident, sickness, or unemployment, also contributed to the breakdown of consumer trust (Lecture 4, slides 7-9). Poorly constructed incentive schemes encouraged public bank employees to continue their inappropriate conducts and they were often paid high levels of unjustified remuneration. Ahmed (2014) reports that despite the profits falling at Barclays, the bank announced an increase in bonuses by £200m in 2013. According to the Barclays CEO Anthony Jenkins, the bank was forced to increase bonus payments to senior executives so as to avoid ‘death spiral’ after hundreds of key staff left the organization in America (Ibid). Although the thoughtless policies and moves of banks resulted in the financial sector downturns, the UK government used the public money to pay those mistakes. According to the Parliamentary Commission on Banking Standards, the bailout money represented an equivalent to £2,000 for every person in UK (Lecture 4, Slide 16). As a result, there were cuts in the bonuses, and generous pensions and the situation hurt the interests of the general public. This financial market scenario created a public perception that banks were not operating in the interests of the public. The Libor Rigging scandal (a practice of interest rate manipulation) reported in June 2012 significantly weakened the credibility of financial institutions and subsequently consumer confidence in the financial services industry was also affected. The FSA (now FCA) fine Barclays a record £59.5m for Libor Rigging. Many consumers thought that such an unfair corporate behaviour may not be restricted to a single bank (Lecture 4, Slides 17-19). In addition, lack of individual responsibility was another factor that drastically influenced the consumer perception of the industry. Executives and employees in the UK financial services industry were not fully accountable for their operations and this situation limited the fairness of financial transactions. Significance of consumer trust Trust forms the basis of all financial transactions and hence it is critical to the financial services industry. The sellers and buyers in a financial services market may be separated geographically, and hence both sides of the transaction may be also separated with advance or late payment. Arguably, sellers will have deeper product knowledge than the buyer. If there is no element of trust, the transaction is not likely to take place or the transaction would delay until lawyers have conducted deep enquiries into the counterparties’ ability to pay and drawn up stringent contracts. There would be still an exchange of contracts even if both the parties trust each other, but they would begin to work with the summary and groundwork for the transaction before such contracts is signed. The parties involved in the contract must trust that the legal system has the potential to settle the dispute in a consistent and predictable manner in case of a breach of contract. A much higher degree of trust between the parties is essential if the country’s legal system is weak. In addition, both the parties should maintain trust in the integrity and solvency of financial intermediaries involved (if any) (Government Office for Science). “Hence trust is a cost-saving and time-saving phenomenon that leads to more and cheaper transactions and thus higher real incomes and greater wealth” (Ibid). In the modern market context, trust is a key factor essential to expedite transactions and to improve earnings. The element of trust is not only required to carry out a single transaction but also to keep both the parties loyal to each other in the future transactions. In the financial services industry, trust is really critical to convert private savings into private and public investments and consumption. It is identified that a great public trust in the honesty and integrity of the financial services sector can lead to the creation of fair and more efficient markets, which in turn would provide better outcomes for all (Lecture 5, Slide 17). In addition, the element of trust is necessary to perform the four essential functions of the financial services sector. In the absence of the trust factor, customers would not be willing to risk their money by depositing with banks and other financial institutions. In other words, customers may be willing to keep their money with them fearing that they would lose their money, and this situation would end up in a frozen credit market. The financial services sector cannot attain a competitive growth rate unless there is an effective circulation of money in the market. Money is the lifeblood of any business, and financial services industry is no exception. In the absence of trust, the firms operating in this sector cannot raise adequate funds to meet their daily needs and to finance their industry expansion plans. Hence, the industry would fail to deliver competitive services to clients if the level of public trust is low. According to Morris and Vines (2014, p.7) trust is particularly important to promote the functionality of the financial system. The authors say that there is a continuing relationship between the purchaser and the provider in the financial services sector that lasts a long period of time. When a customer purchases a financial asset, he/she exposes himself/herself to the risk that the promise of returns may not be fulfilled or that the asset itself may lose its value gradually over time. Here the purchaser must trust the provider that a good return will be delivered in due course. The writer specifically state that untrustworthy behaviour can have serious negative impacts on the financial services industry (Ibid). If the level of public trust in the financial services sector is low, then people would choose to engage less. For instance, clients may hesitate to invest more in their pension funds fearing that the industry would utilize these funds in a way that reduces their rate of return. Customers may choose to save less or purchase fewer if they are uncertain about the trustworthiness of the financial providers. As Morris and Vines (2014, p.8) point out, this situation will have adverse effects on both the industry and the economy as it minimises the availability of capital for productive purposes. A high level consumer trust can assist the financial services industry to improve the quality of its services to a great extent as financial provider can simply skip the task of building consumer trust devoting much more time to brand development. In short, consumer trust is the crucial factor that connects purchasers and providers and determines the volume of transactions in the financial services sector. Restoration of the consumer trust The UK government has taken several measures to restore consumer trust in the financial services industry. According to the final resolution framework published in 2014 by the Bank of England, taxpayers should not bear the cost of bank failures. It also states that bank failures should have “the same impact as the failure of any other institution” (out-law.com). This policy guarantees that the UK government would not utilise public funds to recapitalise struggling financial institutions including banks anymore. The plans set out in this policy framework are split into three phases such as stabilisation phase, restructuring phase, and the firm’s eventual exit from resolution (out-law.com, 2014. In the stabilisation phase, the Bank will terminate senior managers who bear the responsibility of the failure and appoint new senior management to refresh the operations of the institution. Here, the Bank is empowered to transfer some of the failed bank’s business to third parties like a private purchaser or bridge bank prior to an onward sale (ibid). Once this new legal regime is fully in force, then the leading banks will be required to issue debt that could be bailed in times of financial struggles equivalent to 8 percent of their assets. If any bank is unable to raise adequate funds from shareholders and creditors, then the proceeds of the annual bank levy will be used by the Bank to stabilise the institution. One of the major provisions of the new policy framework is that banking institutions will have very limited powers of ‘temporary access to public funds’ (ibid). Once the stabilisation process has been completed successfully, the restructuring phase begins and here the banks are expected to adopt appropriate measures to address the real causes of the failure and to restore the consumer confidence. In this stage, particular focus will be given to maintaining critical economic functions. The failed banks will be allowed to continue their operations only if they are able to demonstrate that they have been capitalised to a level that is sufficient enough to regain consumer trust and to access private funding markets (ibid). This comprehensive policy framework may be effective restore consumer confidence the country’s banking industry. In addition to reforming the way its banks and the regulatory system work, the UK government pays attention to making sure that the country’s financial system benefits the public to access and manage their financial products with utmost ease and confidence. For this, the government is striving to develop a competitive financial services market that is capable of enabling the people to be responsible for their own finances and to plan for the future. In 2011, the UK government introduced Money Advice Service with intent to give consumers free, unbiased, and independent advice regarding the better management of their money and to improve people’s knowledge of the UK (GOV.UK, 2014) services industry. In addition, the government has taken a series of initiatives to make it possible for more people to access banking and other essential financial services. There were many recent financial sector reforms aimed at providing consumers with more information and power about bank and credit card charges. For instance, currently the government offers specific procedures for consumers to take combined actions through the courts GOV.UK). The Financial Conduct Authority (FCA) requires banks to address the situations of mis-selling and regulatory breach effectively (Ibid)). Similarly, many approaches have been proposed by both governmental and non-governmental agencies to restore consumer trust. One of the best recommendations is to enhance the quality of customer services so as to influence their attitude toward the country’s financial services sector. The country’s financial service organisations are advised to develop proper mechanisms to measure customer experience accurately and to report the information to the board regularly. It is also advisable for organisations to set benchmark customer service performance and to compare them with leading players in other sectors. In addition, it is particularly important for the financial services sector to focus more on the online consumer experience because today a vast majority of the customers depend on online financial services. Financial regulatory bodies suggest that it would be a better approach to measure consumer trust in the organisation regularly to be kept informed of the varying consumer perceptions of the industry. It may be a great strategy to publish consumer satisfaction results so as to demonstrate the institution’s commitment to excellence. Finally, there should be a shared vision of customer service which is understandable to everyone in the organisation. Conclusion From the above discussion, it is clear that numerous factors including a series of bank failures across Europe and America, an unfair sales and bonus culture, bailouts, interest rate manipulation, lack of accountability, and poor access to banking services ruined the consumer perception of the UK financial services industry. As a result, consumer lost their trust in the industry, and hence they tried to abstain from investment activities. In turn, this situation negatively affected the market circulation of money, and consequently the whole UK economy experienced a slump in growth. It is identified that consumer trust is crucial in the financial services industry because trust is the basis of every transaction in this sector. In the absence of trust factor, money would stay idle in the hands of people and such a situation may adversely affect the development of the financial services industry. In response to the low level consumer trust in the industry, the Bank of England passed a new resolution that eliminates the financial burden of bank failures from the public. In addition, the UK government focuses increasingly on enhanced customer services to restore consumer trust in its financial services sector. References Ahmed K (March 5, 2014) Barclays: We paid bonuses to avoid death spiral’. The Telegraph. Available at: http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/10676908/Barclays-We-paid-bonuses-to-avoid-death-spiral.html BBC News (September 3, 2014) Regaining trust in banks years away, says Andrew Tyrie. Available at: http://www.bbc.co.uk/news/business-29046605 Confederation of British Industry. Financial services. Available at: http://www.cbi.org.uk/business-issues/financial-services/ The Financial Brand (March 20, 2012) Study Shows Consumers Distrust Banks More Than Any Other Industry. Available at http://thefinancialbrand.com/22896/edelman-banking-financial-services-consumer-trust-study/ GOV.UK (August 14, 2014) Making it easier for people to access and use financial services. Available at: https://www.gov.uk/government/policies/making-it-easier-for-people-to-access-and-use-financial-services#content Government Office for Science (n.d.) Trust and reputation in financial services. Available at: https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/289064/12-1090-dr30-trust-and-reputation-in-financial-services.pdf IHRR Admin (September 25, 2013) Lest we forget: British banking during the global financial crisis. Available at: http://ihrrblog.org/2013/09/25/lest-we-forget-british-banking-during-the-global-financial-crisis/ Morris N & Vines D (2014) Capital Failure: Rebuilding Trust in Financial Services. UK: Oxford University Press. out-law.com (Oct 27, 2014) “Taxpayers should not bear the cost” of bank failure says Bank of England as final resolution framework published. Available at: http://www.out-law.com/en/articles/2014/october/taxpayers-should-not-bear-the-cost-of-bank-failure-says-bank-of-england-as-final-resolution-framework-published/ PWC (December 2012) The Total Tax Contribution of UK Financial Services. Report prepared for the City of London Corporation. Available at: http://www.cityoflondon.gov.uk/business/economic-research-and-information/research-publications/Documents/research-2012/Total_tax_Contribution_OnlineVersion_PDF.pdf (1) PwC blogs (October 2, 2014) PwC research: Financial services industry faces bigger problem than lack of trust – apathy. Available at: http://pwc.blogs.com/press_room/2014/10/pwc-research-financial-services-industry-faces-bigger-problem-than-lack-of-trust-apathy.html Lecture Notes. Read More