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CMSE11167 Introduction To Risk Management In Banks

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CMSE11167 Introduction To Risk Management In Banks

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Course Code: CMSE11167
University: The University Of Edinburgh

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Country: United Kingdom


APRA Prudential Inquiry into CBA: Terms of Reference
The purpose of the Prudential Inquiry is to examine the frameworks and practices in relation to governance, culture and accountability within the CBA group, so as:

to identify, in light of a number of incidents in recent years that have damaged the reputation and public standing of the CBA group, any core organisational and cultural drivers within CBA that have contributed to these incidents.

to assess, at a minimum, whether any of the following areas, or their implementation, are conflicting with sound risk management and compliance outcomes:
Case study: Instructions
Each student will write an individual report about issues raised in the prudential inquiry into the Commonwealth Bank of Australia (CBA) group focussing on frameworks and practices in relation to governance, culture and accountability within the group.
The report is to address the following specific questions:

What types of problems were identified in the prudential inquiry into CBA that delivered its final report in April 2018 (Australian Prudential Regulation Authority,2018)? How do these problems arise within financial intermediaries? Discuss with reference to recent examples in the financial services industry (using CBA or other financial firms).

How do these problems impact on financial intermediaries and their customers?
What role does regulation play in addressing governance, culture and accountability problems within financial intermediaries?

What actions have financial firms taken to identify and rectify these problems?
How successful have these actions been? Where have they been inadequate?
How can industry practices in this area be improved in the future?


Commonwealth Bank of Australia is one of the largest banks in the country and plays a very important role towards economic strengthen of Australia. The bank embodies trust of millions of customers not only in Australia but also abroad. The report would delve into a series of illegal and unethical activities in which the bank indulged only to attract the prudential enquiry by the Australian government. The paper after unearthing the actions of CBSA would delve into their consequences of the bank and its customers (Commbank.com.au. 2018).
Problems identified in the prudential inquiry in the CBA:
The prudential enquiry discovered several problems in the operations of Commonwealth Bank of Australia which have led to damage to the goodwill of the bank. The inquiry further uncovered that the selling of financial products and providing financial advices to its business and individual customers. The following are the problems which were pointed out by the prudential inquiry:
Mis-selling of loan products and credit card insurance:
The enquiry uncovered in its investigation that the staff of CBA in order to fulfill their own targets often misled the customers of the bank to borrow loans and use credit cards. Acharya and Mora (2015) mention that loans and credit cards are assets to banks and lead to inflow of further income in form of interests. SiThe banks are also able to impose penalty for delayed payment of interests, thereby earning more profits. Fahlenbrach, Prilmeier and Stulz (2017) though do not contradict with this statement, point out that banks in the initial phase have to lend amount towards loans from their own treasury. This means that the financial capacity of the customers to repay the loans, credit card amount due and the interests on time are very important for banks to maintain their liquidity. Thus, this analysis shows that though loans lead to inflow of funds for banks, failure of customers to repay loans in event of bankruptcy lead to immense loss to banks. Greenwood, Landier and Thesmar (2015) point out that due to earn interests banks often force their sales personnel to sell loan products. The prudential investigation committee uncovered in this respect that CBA staff often misled retail customers to borrow margin loans without stringent assessment of their latter’s financial capability. This created revenue risks for the reputed Australian bank which further led to erosion of its financial resources (Apra.gov.au 2018).
Inappropriate conduct of the financial advisors Commonwealth Financial Planning:
The inquiry uncovered that the Commonwealth Financial Planning Committee which was set up by Commonwealth Bank of Australia in reality inappropriately misleading the customers to take faulty financial decisions just to earn more profits. The official CBA with respect to the Commonwealth Financial Planning Committee reports that the aim of the committee is to review the financial position of the customers. The advisors of the committee thereafter provide the customers with advices to achieve their short, medium and long term investment goals (Commbank.com.au (2018). The investigation uncovered that in reality the advisors misconducted with the customers and provided with inappropriate financial advises only to induce them to buy more products of the bank.
Fees without providing services:
The prudential inquiry revealed that CBA charged fees from customers in the pretext of providing services but did not provide any quality services. This can also be viewed as a gross fraudulent practices from the side of CBA.
Figure 1. Table showing fees inocme in banks in Australia
(Source: Rba.gov.au. 2018)
The table shown above shows that banks in Australia earn immense income by charging fees on financial products which they offer to the individual as well as business customers. The banks charge more per unit fees for certain financial products like processing credit card request and add on products. This discussion shows that since banks earn high income by serving customers, they are legally and ethically obliged to offer appropriate services to customers. Thus, by not offering services in return of fees, CBA has breached both business laws and ethics.
Using an outdated definition of heart attack and rejecting genuine insurance claims:
The investigation unearthed that CBA rejected genuine heart attack claims based on an ‘outdated’ definition of the cardiac ailment which the bank had printed in the insurance documents and did not update as per modern medical standard definition (ABC.net.au. 2018). CommInsure, the insurance arm of CBA rejected claims of insurance from customers who suffered from heart attacks. This analysis shows that the gross business misconduct was not limited to the loan and financial advisory department of the bank and also encompasses its insurance subsidiary as well. There were media reports that the bank deliberately upheld its obsolete definition of heart attack only to avoid payment of claims to customers suffering from heart attack (In.reuters.com. 2018). This act of the bank could be interpreted as intentional indulgence in fraudulent activities only to avoid making legitimate payments to customers.
Anti-Money breaches:
The prudential inquiry uncovered that CBA has engaged in grave illegal activities involving money laundering, thus breaching law. It can be pointed out that banks Tissot and Gadanecz (2018) point out that banks are financial intermediaries which enable mobilization of financial resources in the national as well as international economy. This makes them soft targets for money laundering groups to filter their incomes from illegal sources into the global economy and prove them as legitimate incomes. The Australian Transaction Reports and Analysis Centre or AUSTRAC is the financial agency of the Government of Australia to monitor financial transactions to check money laundering (Austrac.gov.au. 2018). The Anti-Money Laundering and Counter-Terrorism Financing 2006 mandate the financial intermediaries to verify the legitimacy of the source of income of their customers before entering in financial transactions with the latter (Legislation.gov.au. 2018). CBA opened accounts and entered into financial transactions with parties which were involved in money laundering. Thus, it can be pointed out that the bank has infringed both AUSTRAC and the anti-money laundering law of Australia showing gross disregard for the Australian law.
Impact of above problems on financial intermediaries and customers:
The above illegal and unethical operations of CBA have had serious impacts on the financial intermediaries and customers which are as follows:
Lack of customer trusts:
Rao and Budde (2015) mention that customer trust in the ethical operations of the banks have both short and long term impacts on the bank as well as the economy. The financial products unlike consumer products are invariably high involvement products. Their purchase requires in depth consideration from customers and appropriate financial advice from banks. Purchase of financial products are different from other products because the customers also enter into contracts with the bank on purchasing the products. Moreover, products like investment in shares expose customers to financial market risks in both medium and long term which means investment in certain banking products also create risks for the investors. This analysis shows that banks should provide authentic and appropriate advices to the customers. Thus, in this light it can be pointed out that misselling activities of CBA staff have caused gross infringement of customer trust. This in the short run though would generate high revenue, the bank would lose its customers which would weaken its long term revenue inflow. Moreover, government actions and arbitration cases lodged by investors would damage its goodwill, thus jeopardizing its business generation and acquisition of new customers (Lal and Sachdev 2015).
Fall capital generation and weakening customer services:
The fall in revenue and weakening market goodwill result in waning capital generation, thus preventing the bank from serving customers efficiently. Aldrich et al. (2015) mentions that capital generation forms the base of the operations of multinational public sector organizations like CBA. CBA floats securities in the secondary market in order to raise immense capital. This generation of capital is heavily dependent on the market goodwill of the bank. Thus, waning market goodwill and rampant unethical practices coupled with government actions would force investors to divest in the shares of CBA. Thus would result in fall in its share price in the stock market and lead to lower capital generation, thus further weakening the bank financially.  
Impact on intermediaries:
The fall in capital, market goodwill and revenue of CBA would have negative impacts on the business generation of the financial intermediaries. Hanson et al. (2015) points out that financial intermediaries enable banks to sell their products in markets in which the banks have no direct presence. Thus, the financial intermediaries are dependent on the goodwill and brand power of the bank to sell products (Rao and Budde 2015). Thus, the waning of goodwill of CBA, the bank’s financial intermediaries would suffer financial losses because would be able to sell products of the CBA Thus, it is clear from the discussion that the illegal activities of CBA would have also caused losses to its intermediaries.
Role of regulation in addressing governance:
The regulations are formed to ensure strict governance within financial intermediaries by the banks. The banks like CBA has implemented strict rules and regulations on its intermediaries to ensure that they operate ethically in the market. The bank also has created an infrastructure to probe into customer complaint relating the business conduct of the intermediaries. However, with involvement of CBA in the fraudulent activities, the entire financial intermediary governance was rendered ineffective (Xue 2017).
Actions taken by financial firms to identify and rectify these problems and success rates:
The financial firms like banks have taken strict actions to ensure proper identification of problems and appropriate actions to rectify them. First, the banks form separate invigilating committee to oversee the operations. Secondly, the managers and senior managers are empowered to take decision regarding the legitimacy of the income sources of the customers before selling them products. Thirdly, the sole authority to accept or reject application of asset products like loans and credits. These steps taken by banks aim to identify and rectify the problems faced by banks. However, taking into account the gross infringement of ethics by leading banks like CBA, it can be mentioned that the international governance of banks are not successful in ensuring legitimate banking operations.
Improvement of industry practices:
The industry practices in the banking industry can be improved by stricter laws and actions against banks failing to comply with them. The government of Australia and the RBA should on regular basis monitor the movement of funds in the accounts maintained by the banks. They should initiate immediate if they locate any suspicious transactions (Legislation.gov.au. 2018). The Reserve of Australia should direct banks to collect reKYC of customers on periodic basis like once in two years. These operations would ensure stronger government and control over the banking industry (Rba.gov.au. 2018).
This discussion shows that unethical and illegal activities can endanger the business of even leading banks like CBA. Thus, it can be pointed out that banks should abstain from indulging in unethical practices. They must uphold the trust of the customers and financial intermediaries. They should use the powers placed in them by RBA legitimately to serve the customers and strengthen the economy.
ABC.net.au. 2018. ABC.net.au. [online] Available at: https://www.abc.net.au/news/2016-03-05/comminsure-denying-heart-attack-claims/7218818 [Accessed 11 Oct. 2018].
Acharya, V.V. and Mora, N., 2015. A crisis of banks as liquidity providers. The journal of Finance, 70(1), pp.1-43.
Aldrich, P., Dietz, G., Clark, T. and Hamilton, P., 2015. Establishing HR professionals’ influence and credibility: Lessons from the capital markets and investment banking sector. Human Resource Management, 54(1), pp.105-130.
Apra.gov.au. 2018. Apra.gov.au. [online] Available at: https://www.apra.gov.au/sites/default/files/CBA-Prudential-Inquiry_Final-Report_30042018.pdf [Accessed 11 Oct. 2018].
Austrac.gov.au. 2018. Austrac.gov.au. [online] Available at: https://www.austrac.gov.au/sites/default/files/gn0709-corresponent-banking-july-2007.docx [Accessed 11 Oct. 2018].
Commbank.com.au. 2018. Financial planning. [online] Available at: https://www.commbank.com.au/financial-planning.html [Accessed 11 Oct. 2018].
Fahlenbrach, R., Prilmeier, R. and Stulz, R.M., 2017. Why does fast loan growth predict poor performance for banks?. The Review of Financial Studies, 31(3), pp.1014-1063.
Greenwood, R., Landier, A. and Thesmar, D., 2015. Vulnerable banks. Journal of Financial Economics, 115(3), pp.471-485.
Hanson, S.G., Shleifer, A., Stein, J.C. and Vishny, R.W., 2015. Banks as patient fixed-income investors. Journal of Financial Economics, 117(3), pp.449-469.
In.reuters.com. 2018. In.reuters.com. [online] Available at: https://in.reuters.com/article/australia-banks-inquiry/australias-cba-rejected-heart-attack-insurance-claim-using-outdated-model-idINKCN1LS0D7 [Accessed 11 Oct. 2018].
Lal, R. and Sachdev, I., 2015. Mobile Money Services: Design and Development for Financial Inclusion. Harvard Business School.
Legislation.gov.au. 2018. Legislation.gov.au. [online] Available at: https://www.legislation.gov.au/Details/C2018C00194 [Accessed 11 Oct. 2018].
Rao, Y.V. and Budde, S.R., 2015. Banking technology innovations in India: Enhancing customer value and satisfaction. Indian Journal of Science and Technology, 8(33).
Rba.gov.au. 2018. Rba.gov.au. [online] Available at: https://www.rba.gov.au/publications/bulletin/2018/jun/banking-fees-in-australia.html [Accessed 11 Oct. 2018].
Tissot, B. and Gadanecz, B., 2018. Measures of financial inclusion-a central bank perspective. IFC Bulletins chapters, 47.
Xue, X., 2017. Financial intermediary competition, information acquisition and moral hazard: evidence from peer-to-peer lending platforms. Working paper. https://www. law. northwestern. edu/research-faculty/searlecenter/events/internet/documents/Xue_competition. pdf.

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