Blogging at the crossroads: Off to a great start!

We launched this blog about two weeks ago and, with the site still under construction, have not done anything to draw readers beyond tweeting and linking to the posts.  Therefore, it has been terrific to see that the blog has already received over 550 views.  I’ve also been hearing from people in multiple channels, including LinkedIn and email.  The comments are wonderfully thoughtful and thought-provoking, coming from a wide range of participants in the financial ecosystem. 

The early input confirms my sense that a lot of smart people are thinking deeply and creatively about how we could do better.  I’ve heard from former regulators who have spent decades grappling with these challenges, and from bankers whose whole careers have been about trying to keep regulators satisfied, while doubting it does much good for consumers.  And I’ve heard from people outside the financial arena too, concerned about the things that have gone wrong.

Their comments also confirm my sense that people interested in these issues don’t have many good, safe forums where they can talk openly.  Regulators and regulatees have an inherently adversarial relationship and are rarely candid with each other (I know this from experience, having been on both sides of that divide).  Consumers often feel no one listens.  I’m hoping this blog can be a place where people bring ideas and stories that can cross these boundaries.  I’ll encourage you to post them on the site publicly, but do also feel free to reach me in other ways if you want your comments private.  I’ll keep them that way, but will learn from them and bring them into the flow of thinking in the blog and in my book.

I think one of the biggest barriers to doing better is that no one deeply understands all the valid perspectives – everyone functions mainly inside silos.  This can be a place to break some walls down.

My book will include the voices of people from every corner of the financial services world – consumers, advocates, business leaders, front-line staff in financial companies, compliance professionals, attorneys, technology innovators and investors, media, educators, academics, regulators, legislators -- everyone.  Please keep communicating with me in whatever venue works best for you.

Photo courtesy of Wonderlane

Compliance through Quality

“Regulatory excellence” may sound like an oxymoron but is actually – counterintuitively – the key to cutting compliance costs (and risks). 

My former colleague Lyn Farrell has shared the secret formula for curing most bank regulatory challenges in her new American Banker article. 

Banks are grappling with skyrocketing regulatory risks, and most, not surprisingly, are therefore hiring more people and spending more money on compliance – many thousands of new hires throughout the financial industry.  My own recent ABA Banking Journal article chronicled this phenomenon, which is destabilizing and remaking the compliance profession itself.  These investments are necessary up to a point, but they miss the more important change banks must make to contain the escalation in both risks and costs:  namely, to shift the lead compliance responsibility from the “compliance” function into the business line, and make it a core component of quality. 

As Lyn notes, other industries do this, using zero-defect and LEAN methodologies to be sure their products contain no errors.  Banks, of course, spend tremendous sums on technology and systems to avoid compliance mistakes, but virtually every bank still makes them in their business functions, and then catches and corrects them through their compliance function.  The mistakes are inherently hard to avoid because both the products and regulations are complicated and constantly changing, and also because many banks still use old technology that is not geared to preventing rather than detecting errors.

Most banks will say that their business lines “own” compliance, but few have actually created sufficiently robust systems and cultures in their business units to produce zero compliance defects.  It was not uncommon, a few years back, to hear bankers say they would not want their compliance performance to deserve an A+ rating, because that might mean they were spending too much.  A solid B might suffice.  Accompanying that logic was the assumption that the business line leaders should focus on financial performance metrics and rely on the compliance and legal staffs to manage the regulatory challenges.

That thinking is backwards, because in reality, it’s much more expensive to find and fix errors after-the-fact than to prevent their happening at all.  This is always true about quality – doing things right the first time is by far the cheapest approach.   The banks that truly begin to reverse this old old pattern -- those whose business lines fully internalize compliance accountability, whose business leaders spend time personally thinking deeply about it, and whose technology strategies transform around preventing problems (including meeting the regulators’ evolving standards on “fairness”) – those banks will gain huge competitive advantage.  They will both contain costs and become positioned for growth with minimal regulatory headwinds.

The regulators have a key role too.  They have traditionally set expectations for the “three lines of defense,” with the business unit as the first line, the compliance/risk group as second, and audit as third – by emphasizing the need for independent (and thus) redundant reviewing by all three to assure correct regulatory outcomes.  They want to see very robust second and third lines because, as Lyn rightly notes, they don’t much trust the first lines.  They worry that the business units want to skimp on compliance.

What if banks’ business units could actually win the regulators’ trust?  It would take a lot to overcome skepticism, but embracing “regulatory excellence” is the pathway to lean, clean, low-cost, low-risk regulatory performance.

Lyn’s article maps out how to get there.  As with all of today’s critical compliance challenges, the keys are culture and technology.

As I work on my book, I’m looking for input from both business and compliance people at financial companies on the difficulties of compliance.  I’m especially interested in hearing about costs, and areas where costs are high and benefit to consumers is low – or where consumers are actually harmed by regulatory efforts to help them.  I’ll be interviewing people as well.  I’ll welcome hearing perspectives and stories.

Protecting people from themselves?

I’m thinking about this topic in drafting my book’s chapter on the current regulatory environment.  For those who have commented on my first post, thanks so much for the input.  I’ll welcome more ideas.

A core dilemma in consumer financial protection is how much the government should protect people from themselves, given that over-protection can do as much damage as under-protection by raising costs and drying up markets that consumers want and need.  This issue arises most dramatically regarding expensive products aimed at vulnerable consumers, where regulators worry that people can easily be preyed upon or are simply at high risk of making “bad choices” that will hurt them.   An example is payday and other short-term lending, with which the CFPB regulation-writers are currently grappling.  Should the government bar some options outright because too many people who choose them suffer harm, or should people be free to make such choices, or is the answer somewhere in the middle?

Even among mainstream consumers, there is a thorny question on how to assign “fault” when consumers have difficulties.  People get hurt in their financial dealings for a range of reasons involving varying kinds of fault by them and by others.  Sometimes they just make poor choices – spending, borrowing, or paying too much, saving too little, signing up for a financial product without studying it or comparing options  – even though the financial products they’re using are completely fair.  At the other end of the spectrum, sometimes people are intentionally preyed upon by unscrupulous providers that target and trick and exploit consumers who are vulnerable due to lack of education or sophistication, or are financially desperate.  In between, there is a wide spectrum of scenarios in which people get into bad situations where the fault, if there is some, could be thought of as shared.  Yes, the consumer could have done a better job of reading and understanding the product terms, but likewise the provider, knowing most people will not understand a complex product, could have made the terms more clear.  Most of these situations have, at their core, the problem that the consumer does not thoroughly understand the product.  Classic market forces often fail in consumer financial transactions because the “willing buyer and willing seller” do not have equal knowledge.  The seller almost always has an advantage.

Most financial transactions live in this murky middle ground.  Providers correctly meet legal requirements but offer complicated products they know most consumers don’t understand.  Consumers largely ignore the disclosures and sign up without comprehending the product, based on their trust in the provider and generally being too busy to delve into detail.  Buried in the product’s complexity are, often, features that work to the provider’s advantage.  The consumer could theoretically have found these features and sought to negotiate them or to find another provider, but didn’t.  Then something happens to bring this feature to the surface, and the consumer feels harmed.  Whose fault is that?

Before the financial crisis, the prevailing view was these kinds of problems were consumers’ fault – that if the provider had met the technical legal requirements,caveat emptor should rule.  Post-crisis, the regulators, and especially the CFPB, are emphasizing that products also must not be “unfair.”  Despite some legal case history on UDAAP  (the ban on unfair, deceptive, and abusive practices), it is not clear how these emerging standards should apply.

The issue can be framed as a question:  which party should have to be the active player, and which can be passive, in assuring that consumers have good outcomes?  Must the provider actively try to assure that consumers understand all adverse product terms, and maybe even try to assure that people make “good” choices, or even make the choices that are “best” for them?  Or should the provider be free simply to offer products that meet legal requirements, and put the onus on the consumer to be the active player who must understand and choose well? 

Again, the latter system has largely prevailed in the past and hasn’t worked terribly well, as evidenced in the subprime mortgage crisis, for one.  However, forcing the provider to be responsible for customers making “suitable” choices (a concept that shapes securities law), raises profound questions as well in terms of consumer freedom, risks of adverse customer stereotyping, the huge difficulties of enforcing subjective standards, and the potential to drive providers out of important markets due to fear of regulatory risks they can’t assess.

And what if the regulators decide, instead, to divide up responsibility between the customer and provider differently based on types of products, providers, and consumers?  How should they decide – using what criteria – on where to draw those lines? 

Again, please share your thoughts and stories with me, whatever your perspective and experience may be.

photo credit: Matt Van Buskirk

The Conundrum - How do we create a better system for consumer financial services?

THE CONUNDRUM

I’m working today on my book’s opening chapter, tentatively called, “The Conundrum.” 

How do we create a better system for consumer financial services?  We want it to have certain traits:

• High protectiveness -- against unfair, deceptive, and abusive practices and discrimination
• High availability – with many competing choices, and easy to access
• High affordability – with competitive prices, and with basic services for lower income people

And a corollary is that the system needs innovativeness, to keep all three of these traits improving over time.

Here’s the conundrum:  these characteristics don’t go together.  If we push for more of one, we generally get less of another.  High protectiveness, in the form of government regulation, tends to reduce availability and affordability, because providers respond by offering less of the highly-regulated product and/or by building regulatory costs into what consumers must pay.  Those effects are mostly invisible, but are very real. Conversely, low regulation can incent high availability, but can leave consumers at risk, especially since financial services are so complex that most people don’t understand them well.

Our system currently pretends these tradeoffs don’t exist.  Broadly speaking, politicians, regulators and advocates seek ever-higher protectiveness, as if this has no drawbacks for consumers.  Meanwhile the financial industry and its champions do the opposite, arguing for low regulation as if free markets never cause consumer harm.  Both sides usually mean well, but both views are wrong, or at best incomplete.

My book is going to grapple with this and argue for fresh thinking.  As I start this journey in chapter 1, the questions are clearer than the answers, but I’ve mapped out much of what lies ahead. 

First, the most critical thing – the reason for high hope – is that we can now leverage innovative technology as it changes everything – how financial services are designed, delivered, priced, selected, used, and regulated.

Second, we should accept that the old system’s reliance on mandatory consumer disclosures was a logical approach that has mostly failed.  Instead of burying consumers in paper and boring them with mouse-print, we need to provide  interesting information, especially in their smart phone.   This will improve protectiveness, availability, and affordability, all at once.

Third, let’s face the fact that disruptive innovative technology is about to blow the circuits of the regulatory machine.   Regulatory change takes years.  Market change – big change – is coming daily.  Old industries, and the old regulatory agencies built long ago to oversee them, are being undermined and superseded by whole new financial products and channels and whole new consumer behaviors.  We are going to have bad outcomes – under-regulation, over-regulation, inconsistent regulation, and outright wrong regulation – if we don’t begin to think differently.  One key, here, is that a new agency is on the scene, the Consumer Financial Protection Bureau, with a new design and new kinds of powers, that could make things much better, or potentially much worse.

Financial services can’t solve all the world’s economic and cultural problems, but they matter.  Optimizing the conundrum’s three traits can help people of every age, race, income level, and lifestyle build flourishing lives, whether they are students, retirees, workers, new immigrants, growing families, or entrepreneurs, whether financially on track or at risk, whether financially sophisticated or vulnerable.

I’m collecting stories as I write, from consumers, providers, advocates, regulators, educators, from in the U.S. and beyond, everyone.  Good stories and bad stories.  Please email me, and I’ll blog about what I learn from you as the book takes shape.