When Matthew started working for one of the UK’s biggest banks in the late 1990s, he didn’t think there was anything wrong with selling payment protection insurance. Soon, the pressure to sell policies to people who didn’t need, want or understand the cover they were signing up for made him feel ill.
“There were often times I would go down the back lane behind the branch and be physically sick because I was so frightened about going into work,” says Matthew, who asked the FT not to use his real name as he still works with Lloyds Banking Group.
The short-term result was a cut-throat sales culture that saw stories like Matthew’s repeated in thousands of bank branches across the country. The most successful account managers were rewarded with bonuses, booze and all expenses paid holidays. The long-term result was the UK’s largest consumer mis-selling scandal.
In those two decades, Lloyds has put aside £20bn to settle potential mis-selling claims, topping a list of UK lenders who collectively expect the PPI scandal to cost them close to £50bn.
With the passing of a final deadline for compensation claims on Thursday evening, the finance world hopes to draw a line under the scandal. Bankers are privately keen to say they have learnt their lessons and cleaned up their act.
Yet this week, one of the UK’s most senior financial regulators shared concerns that banks needed “a generation” to fix the cultural issues that led to such rampant mis-selling.
Jonathan Davidson, director of supervision for retail and authorisations at the Financial Conduct Authority, told the FT that while lenders had made genuine efforts to reform, he was concerned that progress could be reversed if a recession increased pressure on their main sources of income.
Today’s competitive banking landscape has parallels with the 1990s and early 2000s when prices for many basic products and services were falling to unsustainably low levels. Unwilling to lose market share by raising prices, lenders instead pushed staff to cross-sell more profitable products like PPI at any cost.
Some insist a problem on the scale of PPI could never happen again. Nevertheless, regulators, consumer groups, and the claims management companies that sprang up in the wake of PPI are already eyeing several new areas that could prove to be the next consumer mis-selling scandal.
PPI set a precedent — much maligned by executives and investors — that firms could be retroactively punished for historic practices judged to be unfair, even if they weren’t against any rules at the time.
Rob James, a portfolio manager and financial services analyst at Merian Global Investors, says: “It is a bit of a known unknown — we know that things could happen but we don’t know when or where. My worry spreads a little wider than the banking system now.”
That precedent of retroactive punishment is already wreaking havoc on the UK’s high-cost short-term lending sector, which has provided a lucrative — but temporary — alternative source of income for claims management companies as PPI compensation tails off.
Payday lending grew rapidly in the aftermath of the financial crisis as mainstream banks became reluctant to lend to riskier borrowers, but firms such as Wonga were criticised for extending loans with interest rates as high as 5,800 per cent. The FCA introduced a cap on charges in 2015.
At the time, regulators assumed the cap would force some particularly exploitative or inefficient firms out of business, but expected more mature lenders to be able to ride out the disruption. However, the sector has since been inundated with complaints about unaffordable loans issued under the previous regulatory regime.
The Financial Ombudsman Service has been sympathetic to historic complaints, prompting a 130 per cent increase in the past financial year. Furthermore, the FOS charges companies a £550 processing fee for every complaint it handles beyond the first 25 each year, regardless of the outcome. The cost of dealing with the influx of claims from CMCs has been a major factor in the collapse of Wonga and others — showing the huge drain of their consumer redress operations.
Revenues in the financial services claims management sector increased almost sixfold between 2009/10 and 2017/18, from £104m to £600m. Now the PPI deadline has passed, claims managers are seeking a new target.
Several hundred claims management firms closed ahead of the PPI deadline, discouraged by more stringent regulations that came into force this year, but there are still 750 companies seeking authorisation from the FCA.
Banking and investment
They may no longer be sending endless text messages about PPI compensation, but the claims managers are still seeking to profit from mis-sold financial products, including investments.
Their aggressive tactics have provoked anger from many within the banking industry. John McFarlane, former chairman of Barclays, was criticised last year for claiming that the companies had “turned portions of Britain into fraudsters” by encouraging spurious claims.
He says his earlier comments had been “sensationalised”, but maintained that the PPI process had encouraged too many illegitimate claims.
“There is no doubt that banks were at fault for the way they exploited this additional source of income and for not putting in place adequate procedures to ensure people weren’t exploited,” Mr McFarlane says, but “we’ve moved on now”.
Consumers may be sceptical of such promises, but the threat posed by claims managers means financial companies now face a major economic deterrent against bad behaviour.
The history of PPI is littered with opportunities for banks to have limited the eventual size of the scandal. The first legal judgment against mis-selling came as early as 1993, but the case was kept from the public under a 10-year confidentiality clause that allowed lenders to keep on profiting. When complaints picked up pace after 2005, the banks resisted at every stage until they were defeated in a high court battle in 2011.
Natalie Ceeney, former head of the Financial Ombudsman Service, was involved in this battle.
“Crudely, the economics were that a bank could do a lot of harm — and make a lot of profit — but only a tiny percentage of customers would complain,” she says. To satisfy those customers, “all you’d need to do [was] give them their money back. But that’s all changed. If something happens now, there is a huge claims industry ready to pounce and a regulator willing to fine. Banks can’t take that risk any more.”
Ms Ceeney says the change in approach can be seen in the way banks responded to more recent criticism over products such as packaged current accounts. Complaints from customers who were sold needless add-ons such as travel insurance alongside their current accounts began to spike in 2015, but rather than resist as they did with PPI, banks were quick to clamp down before it could become a major problem.
A partner at one financial litigation specialist acknowledges that packaged accounts had not proven as lucrative for complainants as initially hoped, but says claims managers will continue to target banks in several other areas.
“The problem with retail banking is they don’t make enough cash from the basics . . . so they will always feel pressured to come up with new products,” the partner says.
Radio adverts that previously exhorted listeners to check if they had PPI are increasingly focusing on mis-sold investment products and Isas. Customers could be eligible for compensation if they lost money on an investment if their bank or financial adviser did not properly explain the risks.
Recent investment scandals, such as the £236m collapse of London Capital & Finance, have also raised important regulatory questions about how well retail investors understand the risks of products such as mini-bonds and Innovative Finance Isas.
Many LCF investors wrongly assumed their mini-bond investments carried some degree of regulatory protection. While LCF was regulated by the FCA, mini-bonds are not, meaning they are not typically covered by the Financial Services Compensation Scheme (FSCS) unless people have invested through official advice.
However, correspondence previously seen by the FT showed that even the FSCS did not spell out this nuance correctly to some bondholders, who are trying to claim compensation after being told they were protected by the guarantee scheme to the tune of £50,000.
The FCA has also been highly critical of the ways Innovative Finance Isas, backed by peer-to-peer investments, have been marketed to those with cash Isas. It is now considering placing restrictions on which products unadvised retail investors can buy over the internet.
The litigation partner says he also has concerns that many banking customers had paid high fees for the promise of actively managed stocks and shares Isas which carried on charging high fees when they moved to more passive investment strategies.
“I think a lot of the future claims will have different characteristics to PPI,” he adds. “With products like investments, the volumes will be less, but the quantum of each claim could be much higher.”
Pensions and business banking
Some of the most valuable mis-selling claims of all are likely to come from the largest investments — namely, pensions. The pension freedoms of 2015 were designed to give those approaching retirement more choice, but the changes have opened up a number of mis-selling opportunities.
“If you have a really good defined benefit pension, it’s incredibly valuable. Consumers often don’t understand just how valuable it is to have guaranteed income for the rest of their life,” says the FCA’s Mr Davidson.
In July, the FCA warned that much pension advice was “not of an acceptable standard”, and outlined plans to ban a type of “contingent charging” that incentivises advisers to encourage as many customers as possible to transfer their pensions, and then charge them a high premium for doing so.
The regulator is also in the early stages of probing banks’ treatment of small business customers. Some companies are already fighting high-profile complaints from individual customers; CYBG, Lloyds and Danske Bank were all targeted by hunger strikers this week complaining about issues including mis-sold loans.
However, a probe by the FCA could raise more fundamental questions about the area of small business lending. The regulator has so far committed only to “exploratory work” on the sector, but has raised concerns about trends such as high transaction charges on business current accounts and other services such as foreign exchange.
Ranked in order of size, the mis-selling of interest rate swaps to business banking customers is the second-biggest scandal after PPI, albeit a fraction of the size at just under £5bn
Other scandals in business banking to have emerged since the financial crisis include a major fraud at HBOS’s Reading branch, and the exploitation of struggling businesses placed in Royal Bank of Scotland’s disgraced Global Restructuring Group.
A new kind of mis-selling: customer data
While the FCA’s Mr Davidson mentions both SMEs and pensions as key areas of concern, he predicts the biggest problem could come from a new type of mis-selling.
“The next big question is about data. It is incredibly valuable, and it is our intent that customers benefit from the value,” he says.
Established banks and technology specialists from start-ups to giants such as Amazon have spoken about their desire to use advanced data analysis to create new, more personalised types of financial products at lower costs.
But a recent report from the Bank for International Settlements — the central bank for central banks — warned that firms could use the same information to exploit customers. For example, studying customer data could allow lenders to overcharge by working out the maximum rate a borrower would be willing to pay for a loan, rather than competing to give them the cheapest available deal.
Data-driven banking is in its early stages, but regulators are not alone in keeping a close eye on developments. The litigation partner adds: “This is very much a space that we are keeping an eye on.” He says that previous breaches of data rules had generally been dealt with through firm-level fines rather than by compensating individual customers, but predicts that in time “this will probably change”.
The idea that the regulator could retroactively “move the goalposts” to allow customers to complain about old products was the biggest source of criticism from banks during the PPI scandal. A former executive who worked at several banks that sold large volumes of PPI argues: “At that time, when customers bought something they were thought to be responsible for knowing what they were doing. That responsibility has dramatically shifted now, but by the standards of the time, no one was deliberately ripping people off.”
The FCA, however, is unmoved by such criticism. AI-influenced products and services are a new area, meaning that many boundaries on acceptable practice have yet to be agreed, and questions over how banks can use customer data are part of a broader debate on the ethics of new technology. But Mr Davidson warns companies against looking to take advantage of this ambiguity and make a quick buck before formal rules are agreed.
“If your purpose or your intent is to use that data to give [customers] a better deal, then you’ll hear nothing but praise for your innovation from me,” he says.
“If you use that data to make more money out of [them], then it’s not going to be a healthy relationship. And you might not be breaching some rules [right now], but that will only be [the case] for a while.”