Watch out for the banks' scams

Would you buy an investment product from a bank? Millions of people do. Indeed, banks and building societies are still the first port of call when savers want to take a first step away from a simple current or savings account.

Yet all the evidence shows that banks and building societies are the last places you should go for investment products. At best, you are likely to get high charges and poor performance - products promoted by banks tend to languish at the bottom of the performance tables.

At worst, you could be the victim of yet another mis-selling scandal. Banks have been at the centre of virtually all the financial scandals - in structured products, precipice bonds, mortgage endowments, payment protection insurance and even personal pensions - that have done so much to undermine public confidence in the investment industry.

We have all heard stories of pensioners being sold equity-related products when they actually wanted to avoid stockmarket risk, of savers who do not pay tax being recommended products to reduce their tax bill.

Which?, the consumer organisation, has confirmed the truth of these stories. It sent researchers to branches of all the high street banks to ask what they should do with £55,000 that was about to mature elsewhere, stressing that they were near retirement and did not want to take risks.

Only four of the 37 approached gave what Which? deemed to be good advice - two at the four Nationwide branches visited and one each at HSBC and NatWest. Almost two-thirds recommended structured products and six suggested investment bonds - despite the fact that these involve stockmarket risk.

More than a third failed to mention that, because £55,000 is above the £50,000 limit for the Financial Services Compensation Scheme, it should be spread between different organisations.

Regulators appear to be finally waking up to the problem. Lord Turner, chairman of the Financial Services Authority (FSA), took banks to task in a recent speech at an industry conference. He accused banks of focusing on "sales, not solvency".

Developing customer detriment

"Looking back over the last 20 years," he said, "what we see is a series of waves of major customer detriment: products mis-sold, huge and rising numbers of complaints, Financial Ombudsman Service and Financial Services Authority intervention to require compensation against specific complaints, and then full reviews, with huge payments made in compensation."

He admits the FSA was partly to blame. Its focus was on transparency. It encouraged companies to be open about the structure of and charges for their products, and left investors to make up their own minds about the attractions of investment products.

That clearly did not work. Structured products, which promise a proportion of the increase in an investment index and "guarantee" your money back, were so opaque that it was impossible for most ordinary investors, and many professionals, to work out that they could lose everything if a bank they had never heard of, and did not realise they were doing business with, collapsed or had its credit rating downgraded.

Investment bonds have high charges, and it is difficult to work out what they are worth at any one time, let alone what you will get when they mature. Penalties for cashing in early can also be excessive.

What about endowments? The FSA spent months trying to persuade us we should have realised that low interest rates meant we would have to channel the mortgage rate savings into our mortgage endowments.

Yet in the 1980s and 90s, when endowments were being sold in their millions, we were being assured they would provide a nest egg for our retirement as well as pay off our debts.

Lord Turner cites four main reasons why consumers are ripped off so often: investment products are long term and their quality, or flaws, will often not be clear for years; consumers do not buy many investment products so cannot easily compare them; those selling them are more knowledgeable than the average investor; and products are too complicated.

Regulators have bemoaned the plight of the private investor for years, and imposed fines and other sanctions on all the big banks.

But nothing has changed. Now the FSA has announced a review that could finally get to the heart of the matter. It will assess the way banks reward staff for selling investment products, to see whether they are designed to prevent mis-selling.

It is also assessing whether the banks' product development procedures are robust enough to weed out potentially dangerous products.

For many commentators, these selling systems are the key. "It is clear that bank staff are incentivised to sell regardless of the suitability of the product," says James Daley, editor of Which? Money. "We are calling for a ban on all sales incentives for bank staff that could result in mis-selling."

The question is, how radical will the FSA's review be? Bonuses for employees in the investment banking arms of banks are now recognised to have been a major contributor to the financial crisis.

While the FSA has introduced new guidelines that will, for example, require banks that pay high bonuses to hold more capital against banking risks, lavish City bonuses are still the norm, despite political and public pressure to limit them.

The banks are likely to lobby fiercely to safeguard their right to pay bonuses to retail sales staff, and the FSA is not even sure yet what type of recommendation a review of sales incentives will produce.

Dan Waters, director of conduct risk at the FSA, who will be leading the review, expects it to take until next year for the results to be produced. "We will be looking at whether incentive structures are driving [advisers] to the wrong outcome."

While Waters says he does not want to prejudge the outcome, "it may be that we will have to enforce and supervise in a different way," he says.

The hard sell

As anyone can testify who has been badgered by their bank to have an annual review or listen to a hard sell when they simply want to pay a cheque in, banking these days is all about selling.

Danny Cox, head of advice at Hargreaves Lansdown, says one of the problems for banks is that their core products - current accounts, credit card mortgages and savings accounts - are not particularly profitable, as competition has driven margins extremely low.

So staff have to be encouraged to sell other, more profitable, products. The commission on an investment bond, for example, can be as high as 7%.

"Every frontline cashier is treated as a salesman, so they need products that are easy to sell, like structured products, but which are usually poor value," says Cox.

Incentives are usually cumulative. Bank staff will be set targets for one month, which will then be raised for the next month, and the next, regardless of whether the targets have been met. While bonuses used to be a little extra at Christmas, now they make up a large part of bank employees' remuneration.

The banks deny that they sell poor investment products. A spokesman for the British Bankers Association says: "Banks are able to offer a streamlined and efficient - and hence inexpensive - service, negotiate good deals and offer market-leading products due to their size.

They enjoy access to bespoke products not freely available elsewhere on the market. And they are also more accountable for their recommendations: banks are permanent fixtures on Britain's high streets and want to safeguard their reputations. Lines of accountability, regulation and reparation are clear, and advisers are subject to considerable oversight."

Some disagree. The financial scandal and the damage to banks' reputations is inspiring the creation of new banks with a fresh ethos.

Metro Bank launched at the end of July, Tesco and Virgin are adding banking services, US private equity business JC Flowers is taking over Kent Reliance building society as part of its plan to start a new chain, and City luminaries Lord Levene and Sir David Walker are looking to buy banks as part of Project New Bank.

But will they succeed where traditional banks have failed to offer good service, sensible products and low charges? Or will they, too, just be motivated by profit?

Unless the FSA's review comes up with some radical changes, the smart money has to be on the latter.

This article was originally published in Money Observer - Moneywise's sister publication - in September 2010

More about