The UK’s FCA is encouraging firms to think through customer relationship risks in the event of a recession, to avoid a repeat of the mistakes of the Financial Crisis
At first blush, a recent speech by Charles Randell, chair of the Financial Conduct Authority (FCA), may appear to be all about managing credit risk in a downturn – but it’s not. “Stress testing for human beings” focuses on how firms should prepare now to better manage the operational risks associated with an economic downturn, and in particular, ethical and cultural issues around customer relationships. Failing to manage these risks appropriately can result in significant compliance and reputational risk, as well as financial loss.
When the dust settled after the 2008 Financial Crisis, it became clear to regulators and firms alike that operational risk played a significant role before, during, and after the crisis. For example, banks have been fined for mis-selling mortgages before the crisis, and for the damaging ways in which they managed economically vulnerable customers as events unfolded. Randell also noted that downturns have in the past fostered unethical behaviour around pensions and investments, with unscrupulous financial services employees dishing out bad advice that left victims worse off financially, for their own personal gain. Examples include putting client money into high risk investments or telling individuals to withdraw their pension money to earn employee incentives.
Randell noted that the FCA has taken significant action since the financial crisis to punish both firms and individuals who engage in unethical behaviour that leads to damaged consumer outcomes. As well, new rules are on the way to further support economically vulnerable individuals. Even the Senior Managers & Certification Regime (SM&CR) has a role to play, by holding senior managers accountable for the ethical behaviour of employees within their area of responsibility.
However, Randell says both the FCA and firms must broaden their perspectives, and consider how they would act if a recession hit today, when the financial resilience of individuals in the UK remains low. “The Bank of England’s stress tests have demonstrated that the financial system is now strong enough to support the real economy through a severe recession,” he said. “But while the system is financially secure, many people are not. So as a financial conduct regulator, we need to think about what an economic downturn means for the human beings which the system is there to serve.”
Although Randell took great pains to say that the FCA was not predicting an imminent recession, he was asking firms to think beyond the kind of credit risk stress testing they undertake for regulatory capital requirements, and consider the operational risks and ethical dilemmas a downturn might pose. Said Randell, “Senior Managers need to focus on these issues right now.”
It’s clear that the FCA is going to put significant emphasis on customer outcomes in the event of a downturn, and so Randell’s speech presents an opportunity. Firms should consider using scenario workshop exercises to identify the strengths and weaknesses in their operational risks and controls around customer relationships, if a downturn were to happen. They should also consider how their written policies and overall culture support the right outcomes for both the firm and its customers.
The probability of a downturn hitting is a question of “when”, not “if”. Financial services firms that manage customer relationships well in times of economic hardship have the potential to not just avoid regulatory sanction, but to significantly enhance their reputation among consumers for ethical practice, community support, and fair outcomes.
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