Trust in Financial Services

A FEW REASONS WHY NOBODY SEEMS TO TRUST THE FINANCIAL SERVICES INDUSTRY TO LOOK AFTER OUR PENSIONS AND SAVINGS.

The Industry and the Punters...

The Industry.

Almost certainly the largest industry in Britain and becoming ever more powerful given the relative declines of manufacturing and high technology industries.
The structure and composition of the industry is very complex, a large part of it being owned by huge retail and investment banks. The activities that come within the umbrella of 'financial services' range from currency and money management, investment in many guises, insurance, mortgages, retail banking and pensions. In the UK, there are two major centres that host large concentrations of financial services companies, in London and Edinburgh - and several other more minor specialist clusters in cities such as Leeds.
As a general rule, the majority of investment-related activities, such as share broking, investment banking and institutional investment are dominated by huge American, German and Swiss companies - serious British investment banking players failed in the 1980's and early 1990's.
The retail banking and insurance sectors contain more indigenously owned companies, although foreign companies are making serious inroads here too.

As this is not a treatise on the structure of the industry, it is sufficient to cover only the elements of the financial services industry that have a direct influence and impact on the lives of the average citizen. This includes high street banks, insurance companies, mortgage companies and the whole pensions industry.
Of course behind all of this is a massive banking and investment complex that can have dramatic indirect effects on our lives, as anyone whose company has been acquired may know.
Even more worrying is the behaviour of the investment industry, which through its periodic orgies of speculative excess can destabilise whole economies and impoverish millions. But as far as the average citizen is concerned, these matters and frequent scandals like Enron and Marsh McLennan are simply background 'mood music'.
What concerns people most is the direct effects of the industry on them and their interests - and this piece is a review of why it is that there is a general unease and mistrust of the industry - placing it alongside politicians and 'people who run large companies' at the bottom of the public trust and esteem chart.
Thus it is that an industry that ought to be a cornerstone of our economic well-being is the object of deep mistrust - Why?
Russell Sparkes of the 'Professional Investor' magazine alluded to the problems facing the industry in his critical review of 'Having Their Cake':

I came away from reading this book feeling rather disturbed. Not because I agree with its conclusions, or because I felt persuaded by its arguments, but because I suspect that it may represent a growing feeling that there is something wrong with the City of London.
Mr Sparkes concludes: This book may accurately reflect a growing view in 'Middle England', which, if not adequately addressed, will ultimately result in much more onerous regulation of UK financial services.
Public scepticism about financial services is also likely to lead to a decline in the UK savings rate - the last thing the British economy needs. In my article in this issue on the Sykes Enquiry, I conclude that the UK investment industry needs to raise its 'ethical game', to become more active owners and re-build public trust.
The publication of Having Their Cake underscores the importance of this task.
As we shall see, Mr. Sparkes is quite right to have a sense of unease about the views of 'middle England' about his industry.

The Punters.

Anybody whose welfare and well-being is affected by our financial affairs - and that means nearly all of us - from the poorest debt-ridden slum dwellers in hock to a loan shark to relatively well-off professionals. Maybe we do not have to concern ourselves too much with the very rich, who can afford to look after themselves.
What stands out a mile is the fact that the population in general is relatively uneducated and naïve when it comes to financial matters.
Here is an illustration provided by Carol Sergeant of the Financial Services Authority in a speech to the Financial Services Industry 'summit' meeting in 2003:

Consumers will have to actively manage their assets and liabilities over their lifetime in a way neither their parents or grandparents have had to do - and they will have to do this over a lifetime which may well see much more change in working and employment patterns than hitherto and more changes in lifestyles, more divorce, co-habitation and single person living. This will all - happily - have to be managed over a lifetime, which will on average be longer, and during which most people expect to enjoy a higher standard of living.

How well equipped are consumers - your customers - to deal with the planning responsibilities and risk management issues - including volatility risk - that this will demand? Most human beings are notoriously poor at long-term planning. People in the UK are also relatively inexperienced and unsophisticated when it comes to matters financial. This is hardly surprising after two generations of mainly welfare state and employer provision. Many consumers have also still not fully adjusted to the implications of a low inflation environment and probably don't understand the liability side risks they are running any better than their savings and investment risks.

It is hard to overestimate the extent of financial illiteracy amongst some consumers. Let me give you some illustrations from recent research. Many consumers have serious numeracy problems. Research by DFES has shown that one in four adults cannot calculate the change they should receive out of £2 after buying three items costing less than that. A significant number thought 10% of £300 was worth no more than £25. Some rather older research by the OFT showed that only 64% of consumers might be expected to draw the right conclusion when comparing 2 APRs and 23% of the sample could not explain what a percentage was.

A more recent survey by NOP for Invesco found that half of investors surveyed (and over two-thirds of the public at large) do not understand the difference between equities and bonds.

The FSA's own research and that of the independent Consumer Panel is also revealing. One quarter of pension and endowment policy holders did not realise that their money was invested in the stock market. 57% of consumers never or hardly ever read the personal finance page in their newspapers. Consumers find financial information difficult to understand and frequently fail to read or retain the information provided. 56% of consumers agree or strongly agree with the statement "I find it hard to understand financial leaflets". Even products designed to be simple confuse consumers - only 33% of consumers thought cash ISAs were straightforward for example.

The Punters and the Industry.

Why do the public feel the way they do about the Financial Services Industry? Are they the victims of propaganda or malicious negative 'spin' by such as the authors of Having Their Cake?

Here is a short collection of events and perspectives that have impacted on the public consciousness in the last 20 years.......

• Personal pensions mis-selling. The pensions industry, taking advantage of the deregulation of the provision of pensions and the opportunity to sell people alternatives to their occupational pensions, sold millions of personal pension plans, frequently grossly over-selling their benefits by comparison with previous arrangements.
  Millions lost out and eventual compensation, delivered reluctantly by the pensions companies, amounted to more than £15 billion. This represented deception on a bewildering scale, and scarred many people.
• Endowment Mortgages. Individuals were sold insurance-based savings schemes that were initially guaranteed to mature and pay off their mortgages at a specified future date. Unfortunately, investment returns were not sufficient to cover the whole mortgage, and hundreds of thousands, if not millions, of people were left with large shortfalls that they did not expect. Again, another example of mis-selling by the industry, leading to a shortfall of some £40 billion - that's a lot of shortfall for a lot of people.
• Precipice Bonds. People were offered very high income returns on investment bonds - what most did not appreciate was that the promise did not cover the value of the investment capital - a large number of individual investors lost large amounts of capital, to the tune of £2.2 billion.
• Split capital investments, initially designed for rich and sophisticated investors, but then marketed to a more general market. Investors expected either to receive an enhanced capital sum at the end of an investment period, or income plus a capital sum. These bonds were sold as safe investments, but in many cases turned out to be anything but.
  Over 50, 000 people lost over £700 million.
• Additional Voluntary Contributions. A large number of prudent people topped up their pension contributions in the expectation that they would receive an enhanced pension at retirement age. The collapse of Equitable Life, a major AVC provider, cost thousands over 50% of their hard-earned savings.

Behind the high-profile cases - a constant stream of lower-level malpractise.

The high profile cases represent the high notes of a discordant symphony. The background 'music', which is likely to impact the public consciousness just as much is an almost daily dirge of mal-practise and excess. Here is a small random sample:

• Pressure selling of loan and credit deals, including sending blank cheques and inviting people to 'take the money now'. The loans and credit industry has bombarded the populace with offers based on the seductive notion that people can have everything that they want - immediately.
  The result is a huge burgeoning of personal debt, which is bound eventually to hurt millions when they cannot repay. Patrick Hosking in the 'New Statesman' gives the example of Lloyds TSB, which badgered a couple into taking on £100,000, despite the fact that the husband was unemployed and mentally ill and the wife was a low-paid part-time nursing assistant.
  An audit revealed that staff were highly incentivised to maximise loans - a sample of 185 loans revealed that 104 were inadequately documented and evidence that a further 31 borrowers could not afford the loans.
  Banks and credit card companies have been publicly castigated by MP's for their 'excessive' rates of interest on loans.
  Lord Griffiths, a vice-chairman of Goldman Sachs, is reported as being very concerned at the £1 trillion plus of unsecured debt in Britain and the social misery and economic disruption that may be inflicted by it. It appears that Lord Griffiths is convinced that the purveyors of such credit and debt need to be curbed in their pressure selling, as all who are bombarded by junk mail offering loans and credit so that we can have anything we want - now.
• Profiteering by banks on credit card insurance, according to the 'Guardian' of April 4^th 2005. About 25% credit card customers and half of loan customers buy payment protection from the banks. About 14% of Lloyds TSB profits and 180% of Egg's come from credit insurance. DTI figures show that only 4% of customers (some of whom are unaware of the fact that it is optional) claim on the insurances and of this tiny minority one quarter are turned down. Consumer groups reacted angrily to what they described as blatant profiteering.
• Charging on ATM 'Hole in the Wall' machines. Following a considerable outcry at the growing habit of banks to charge for the use of ATM machines, the practise was curtailed. Now the practise is creeping back through the back door by banks selling their machines to ATM operators who charge customers. Banks have also been castigated for varying interest payments on savings and loans without direct notification to customers and a variety of sharp practises that have stirred a deep well of ill-will amongst their customers.
• Some Building Societies have been exposed as offering incentives, such as a £3,299 plasma TV to people who sign up for mortgages, sometimes up to 130% of the value of their properties.
• "Standard Life reneges on payouts", says the 'Guardian' of October 6th 2004. Indeed it appears that Standard Life, preparing for flotation, has withdrawn an implied 'promise' to bail out mortgage endowment holders facing shortfalls. Says the 'Guardian', The move affects 600,000 policyholders covered by the pledge, many of whom will now receive top-up payments that are tens of thousands of pounds less than they were expecting.
• Patrick Hosking quotes insurance expert Ned Cazalet who told a committee of MP's that the insurance industry spend £5 billion a year on administration and £7 billion on underwriting new business, mainly on commissions to salesmen. Says Hosking, "You have to ask, is an industry that costs £330 per household in administration and £570 per household in commissions each year sustainable?

Mr Hosking wonders if it is helping our children "...if we encourage them to hand over money to firms which for 20 years have been mis-selling to their parents and grandparents"?
As Mr Sparkes of 'Professional Investor' has said, deep mistrust of the financial services industry has serious and wide-ranging effects on the attitudes of the populace about important national institutions, undermines government initiatives to have people save for their later lives and generally distorts many peoples' behaviour in the direction of living for the moment. Why forego immediate gratification if you believe that hard-earned savings will be dissipated by incompetent and dishonest institutions?
This is the rub; the financial services industry is one of the pillars of our society, and if people cannot rely on it to act consistently with integrity and competence, it undermines society itself. The real trouble is that the disgraceful behaviour of parts of the industry causes the whole to be tarred with the same brush.

Transgressors in the financial services industry should have to pay dearly for ruining peoples' lives, 'pour encourager les autres' to look to their integrity.

Quotes

"...I have yet to read a more devastating analysis of the self-serving relationships that can exist between public company chief executives and investment banks than that outlined in Having Their Cake

Richard Donkin, Financial Times

© Scott Young Ltd 2004

IBAS thank Don Young for permission to reproduce the above text and information from Having Their Cake. Visit their website for more information on this book and other publications.

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