InvestmentsNov 12 2014

Foreign retail banks are no saints

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The scale of redress to mis-sold clients suggests that London is tougher on its banks in punishing bad retail banking behaviour than other countries. But overseas banks have their fair share of irresponsible mortgage lending and selling of toxic financial products to the average client.

Even the regional Spanish savings banks, the ‘cajas’, have lost touch with the local communities they are traditionally meant to serve.

The Spanish banks’ speciality – other than fuelling the housing bust in the country– was persuading ordinary savers that instead of putting their savings into simple time deposits they should buy subordinated bonds and preferred shares in the banks.

In 2009, after Spain’s housing bubble burst, the lenders suffered losses on the real-estate loans, and needed to raise capital. Since the international institutional investors started to fear Spanish bank securities, the cajas used their branches to market their shares and bonds to the average Spaniard.

The product was attractive, as it yielded much higher interest rates than regular deposits. As much as €22bn (£17bn) preferred shares were sold to households and pensioners who were assured by their bank branches that their life savings were just as safe in the securities as in deposits.

But when the cajas went into turmoil, the number of investors willing to buy the securities shrank, and the bonds and shares traded at huge discounts in the secondary market. Selling out of them was only possible at a very low value.

Most savers only realised that their money was trapped when they stopped by their local branches to withdraw some of their savings. Their trusted branch bankers had sold institutional investor products to people who did not understand them. And there was no redress.

The reason was that in 2011 the Spanish government used EU funds to bail out the troubled banks, and the European Union said subordinated debt holders and preferred stock owners must share the burden. This prevented a swap of preferred shares back for time deposits.

When Ireland made bondholders take losses, it was politically palatable, because the bondholders were banks and funds. In Spain, the bondholders were ordinary depositors. Images in the press of vandalized bank branches revealed that some fiery Spaniards sought their own redress.

In Eastern Europe, it is the foreign currency debtors’ debacle that sparks debate on redress.

In the years before the financial crisis, many took mortgages in Swiss francs, as the interest rate was much lower than in the local currency. When the crisis erupted, international investors piled into the Swiss currency, causing the franc’s value to soar against the Polish zloty or Hungarian forint, resulting in many Eastern European households struggling to meet their escalating monthly repayments.

The post-crisis bank-bashing in Eastern Europe was mainly driven by the problems of forex loan borrowers. Before the crisis, the governments were happy to see a lively lending market, as poorer citizens were made to feel well-to-do thanks to low-cost consumer and housing loans.

In Hungary, the issue of ‘revenge’ has become highly politicised, so redress is not initiated individually through claim companies, but rather has been elevated to parliamentary levels. The government of Prime Minister Viktor Orbán has introduced relief packages with an option to convert the foreign currency mortgages into forints at a very favourable exchange rate, forcing the banks to book most of the Forex losses. Parliament has also passed legislation forcing the banks to reimburse the charged Forex spreads, retrospectively.

The ruling has deemed the banks’ practice of using higher exchange rates when disbursing loans, and lower exchange rates when calculating repayments – that is, the Forex margin between buy and sell rates – as unfair, and has ordered them to use the central bank’s rate on all transactions, retroactively.

The banks in Hungary claim the retrospective effect of the new law violates the principle of legal security. Other taxpayers with forint mortgages complain that bailing out those individuals who took a failed punt on exchange rates creates moral hazard.

Banks’ mortgage underwriting standards were loose in most parts of the world during the boom years of 2004 to 2008. For brokers, securing the loan for the applicant meant commission.

The phenomenon of interest-only mortgages assumed that house prices only go up, enabling the borrower to pay back the capital at the end. Paying just the interest on the monthly repayments meant borrowers could take much bigger loans. When they saw the price of their houses fall, many wanted to change to a normal mortgage, but, obviously, they failed the tighter affordability tests.

It is important to remember that checking the customer’s budget and affordability is the main focus of the mortgage market review brought in by UK regulator the FCA. After penalising several mortgage brokers and advisers, the FCA has now fined the first of the big high street banks, the Royal Bank of Scotland Group (including NatWest bank) for poor affordability assessments during the mortgage advice process.

The bank’s own mystery shopping research revealed examples of advisers giving personal views on the future movement of interest rates, which the FCA said was highly inappropriate and could have resulted in the mis-selling of products.

Again in the UK, it was the payment protection insurance fiasco that opened up the floodgates to the mis-selling scandals.

There is a fine line between convincing a customer to buy another product, and actual mis-selling. PPI is a secondary product – covering the repayments of the borrower in case of illness, accident or unemployment – so it is sold at the point of sale of the mortgage, just as women are often tempted to buy a handbag to match the shoes they are in the process of buying, as a result of equally high-pressure sales tactics: “You should try that with this, they look fabulous together,” they are assured by the fawning salesperson.

However, many victims of the PPI mis-selling scandal did not realise the insurance had been added so were unaware that they had been paying an insurance premium in their monthly instalments. Others were told it would be better if they boughtthe insurance in order to give the mortgage application a higher chance of going through.

So while banks are refunding almost all PPI premiums to their naïve customers, it raises the question: are the people in the UK financially illiterate? Others – receiving unsolicited standardised text messages from claims management companies promising thousands of pounds in compensation – wish their bank had indeed sold them PPI. The billions paid out in the form of refunds is welcomed politically: it is a sort of quantitative easing for the common people, boosting consumer spending power.

What is alarming in the PPI case is that it is retrospective. It sets a precedent that in a couple of years’ time we can look back and say, “actually, that practice was not acceptable”.

If you ask a risk manager what is the next ‘ticking timebomb’ they are making provision for, it is paid-for current accounts packaged with travel, home or mobile phone insurance.

“When a customer walks into a branch wanting to open a current account, he has the choice of the simple and free account,” a bank’s internal auditor for regulatory affairs explained, adding: “But more probably he would be up-sold by the incentivised sales staff, and get an account with lots of bells and whistles for which he is charged a monthly fee, and leaves the branch as a ‘platinum client’.”

The branches, of course, are not staffed with private bankers, but with salespersons.

“A few years ago, we took away the knowledge from the branches, and focused them on sales, sales, sales. The concept was that a branch should feel like a burger bar,” a HR manager said, referring to how customers walk in to buy a simple cheeseburger but end up walking out with a meal of cheeseburger, coke and fries.

Will all this redress be contagious to other industries? Broadband internet and TV are usually bundled with a mandatory telephone landline. But Ofcom, the communications regulator, is happy with the fact that prices for bundled services are cheaper than the equivalent total price of standalone services.

However, other industries are much more strictly regulated than the banks. A compliance officer said: “Banks should operate like pharmaceutical companies, testing every product before selling it.”

Maria Sovago is a freelance journalist

Key points

* Overseas banks have their fair share of irresponsible mortgage lending and selling of toxic financial products to the average client.

* In 2009, after Spain’s housing bubble burst, the lenders suffered losses on the real-estate loans and needed to raise capital.

* In the UK, it was the payment protection insurance fiasco that opened up the floodgates to mis-selling scandals.