CORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 860-ii

HOUSE OF COMMONS

HOUSE OF LORDS

ORAL EVIDENCE

TAKEN BEFORE THE

PARLIAMENTARY COMMISSION ON BANKING STANDARDS

SUB-COMMITTEE J

PANEL ON MIS-SELLING AND CROSS-SELLING

THURSDAY 17 JANUARY 2013

STUART DAVIES, DOMINIC HOOK and GED NICHOLS

PAUL GEDDES, GORDON PELL and GUY WHITTAKER

USE OF THE TRANSCRIPT

Oral Evidence

Taken before the Parliamentary Commission on Banking Standards

Sub-Committee J-Panel on mis-selling and cross-selling

on Thursday 17 January 2013

Members present:

Lord McFall of Alcluith (Chair)

Mark Garnier

Mr Andrew Love

Mr Pat McFadden

Lord Turnbull

Counsel: Adam Tolley

Examination of Witnesses

Witnesses: Stuart Davies, Regional Officer, Unite the Union, Dominic Hook, National Officer, Unite the Union, and Ged Nichols, General Secretary, Accord Union, examined.

Q276 Chair: Good afternoon and welcome to this panel on mis-selling. Could I start by asking you about your evidence? It suggested that your members expressed concerns over a long period about what they were asked to do by the banks. I am interested to know where your discussions took place. Was it with senior people in the banks? Did they take your concerns seriously about what you or your members were raising? Was your interest your members’ welfare or did you have an interest in consumers’ welfare as well, given that the products were mis-sold?

Stuart Davies: The two are inextricably linked. The treatment of our members on a day-to-day basis within the banks feeds into the treatment of customers on a day-to-day basis. Our concern sits around a very, very aggressive sales culture that sits in the banks and a very aggressive performance-management culture that exists in the banks, to the extent of e-mail trails that go round and round individual performance on performance targets and whiteboards that contain information on individual performance. That feeds into increased pressure on staff, which feeds into, perhaps, some dysfunctional selling to customers, because they are concerned for their jobs. They are concerned for their own welfare in terms of the bank performance-managing them, giving them 0% pay rises and giving them zero bonuses. That influences and directly impacts their treatment of customers on a day-to-day basis, but what we do need to be clear on is that our members are hard-working and diligent. They are not setting out to act dysfunctionally within the workplace, but the pressure that is applied by the employers unfortunately leads to that kind of behaviour on occasions.

Q277 Chair: What about the product being sold? Did you think it was a bad product anyway? Were you advocating to senior management that it must change?

Ged Nichols: I do not think-apologies for my croak-that implicitly the people who were selling payment protection insurance at the time believed that they were mis-selling or doing something wrong. If consumers were borrowing money and they faced the potential risk of unemployment, to insure their ability to repay the loan was not an inherently bad thing to do. However, that became overlaid with management practices, particularly when there was intense competition in the industry, in the 2005-06 period. Then, a normal personal loan would be transacted at a loss for the bank, because of competition, so the only way to make such loans profitable, when the banks were judged by shareholders and the City on their market share, was to ensure that they had the additional income from payment protection insurance. At that point, the pressure increased. That is when you started to see the difference between offering a sensible protection product and trying to ensure that the product was sold not at all costs, but wherever possible. Of course, consumers did not have any ability to shop around for their payment protection insurance, because there was not an open market; it was linked to the product that they were purchasing.

Q278 Lord Turnbull: I can see how, initially, front-line staff may not have realised the limitations on the policy-the exclusions-and they were therefore selling to people who could not make an effective claim. When things started to go wrong, did dissatisfied customers who were trying to make a claim and were being rebuffed tend to come back to the office that had sold it to them, or did those complaints tend to go centrally?

Stuart Davies: Invariably, complaints that came in would be dealt with centrally by the organisation, rather than go back to the individual seller or the individual manager of that unit.

Q279 Lord Turnbull: When do you think front-line staff began to twig that the products, as I would argue, were specifically designed to exclude quite large numbers of people, but who nevertheless were sold these products? Do you think your staff realised that that is what they were selling?

Stuart Davies: I think that they were aware that there was a high premium placed upon those products, on the basis that they were quite often awarded sales points for their selling of individual products. Each product would be given a different sales value, and quite often a personal loan that contained payment protection was double the value of a normal personal loan. Clearly, members of staff had a clear understanding that there was a high premium placed on those products.

There is also anecdotal evidence that certainly disappointment was expressed when members of staff were unable to sell a personal loan with payment protection, so there was very much a push on that. Clearly, there was growing discomfort among our members that perhaps the products they were selling were not all they were cracked up to be.

Q280 Lord Turnbull: Do you think that from, say, 2005, when the super-complaint was made by the CAB, staff began to twig that this was a faulty product?

Ged Nichols: With the staff who were selling the product properly, the exclusions were made specific. I do not think that, in the main, where staff were selling the product they were selling it for financial gain, as has already been said. The salary levels and even the incentive payments to most people involved at the front end are relatively small. I have never had to defend anybody who has been disciplined by a bank for the mis-selling of payment protection insurance, which indicates that if there was mis-selling it was by design and it was a corporate issue, rather than the behaviours of individuals in the sales force.

That said, undoubtedly some mis-selling did occur. I am not saying that there are not any members of our union who mis-sold, but I think you have to understand the pressure that they were under. Those people were not selling one product; they had a range of financial products to sell-to meet customer needs, in the current parlance-every day of the week. It was not as though you had somebody who was dedicated to PPI and was doing that for the whole of their working day.

Q281 Mark Garnier: Mr Nichols, you are a representative from Accord, so your background is obviously HBOS, which merged with Lloyds TSB in 2008. It is very interesting that you made a reference to the City, the demands of shareholders and all that, because HBOS and Lloyds were two very different animals, as I am sure you are aware. There was a huge amount of criticism because Lloyds was not revving up its balance sheet; it was not taking these practices. Certainly, having met a number of Lloyds staff, one of the interesting points is that the cultural difference between HBOS and Lloyds when they came together was very challenging, in trying to merge them, because of that culture.

The culture at HBOS was very much more aggressive. It was almost as though, if you were the worst salesman, they would take your chair away from you for the week-that kind of thing. What did Accord do as a union to push that back, because it was clearly a management problem? I am curious as to what the union did to try and push back that aggressive culture.

Ged Nichols: On the background, first of all, before I became a union official I worked at the Halifax between 1979 and 1988, so I have spent the whole of my working life in the industry, and I was around prior to the deregulation-the demutualisation of the building societies, and so on; so I have been through that whole period.

I think when HBOS was established, it was established, if people remember, as a challenger to the big four in banking, because there was a perception that there was a lack of customer choice, and inertia-that customers were not getting a great deal; so HBOS was going to challenge the dominance of the four big banks by providing better products at lower prices.

It was the darling of the City. It was growing rapidly. It was offering better products, and for a time there was an alignment between what was in the customers’ interests, what was in the interest of the staff, and what was in the interest of the bank and the shareholders. I think that changed because of the dynamics and the pricing in the markets generally, and through the level of competition from round about 2004, 2005.

Now, although HBOS had, I would say, in the retail business, an informal, friendly, sales-oriented growth culture, that was quite different, as you said, to Lloyds TSB. I am not here to make a case for HBOS or to criticise Lloyds TSB. I think that Lloyds Banking Group, in breaking the mould and coming forward and saying that they would take the hit for PPI, as opposed to continue to get off the hook, was significant and they should be lauded for doing that.

As I said in my submission, much of my time in the last four years has been dealing with the redundancies and other issues that have come out of the merger, rather than entirely looking at things through the consumer angle; but there were different cultures, nevertheless, in the sale of PPI, because the original four big banks did have a far higher proportion of their loan books in personal and unsecured lending. They would have more PPI cases than HBOS, I would imagine. It’s broad ranging, but I hope that’s an answer to your question.

Q282 Mark Garnier: It sort of is. I think what I am trying to get to the bottom of is that one of the functions of this Commission is to try and work out how we can drive improvement in standards and culture, and we look at every sort of way we can possibly do it: professional bodies, regulation, legal sanctions, a whole number of different things-the involvement of directors and shareholders.

It is very interesting to have the unions in front of us, because of course you are representing the interests of your members, and that is absolutely a good thing-I completely go along with that. I think also, in that respect, as an employees’ organisation-I am speaking to all of you now-you, I suspect, do have quite an important role to play in developing the culture and the standards of the industry, of the members you are representing.

What I am really trying to get a flavour of is, we are using PPI as an example, but I am trying to broaden the questioning out to how do you collectively or individually push back. At what point, for example, do your members come to you and say, "Look, we are just worried about this. We don’t know why we are worried. We don’t understand the machinery that’s inside this box of PPI or interest rate swaps, or whatever, but for some reason it looks horrible. We are being incentivised very heavily to do this, we are being pushed to do this; there are certain processes we don’t like. What’s going wrong?" I think what I am trying to get from you is how you go back to the management and say, "There’s a problem; we don’t know what it is but we need to deal with it."

Ged Nichols: If my colleagues do not mind me answering first, in our case, if you take people in the branch network, we meet all the union representatives at least twice a year together throughout the UK. You can tell from the issues that the union representatives bring forward whether there is localised bad behaviour which you have mechanisms to address or whether you have systemic problems. If you have systemic problems, because they will tend to come out in all the different regions, we would talk to the company’s management about them and hold up a mirror and play back to them what the work force are saying about some of those cultural issues. We will also meet at least quarterly with the bank to review the incentive arrangements, the performance against the targets and what levels of bonus are being earned by people in all the different jobs.

One issue that the bank consistently countered us with was what they called the bandwidth of performance. Although we were representing the views of some of the work force that were complaining about mis-selling, pressure and so on, they were saying, "Here’s the bandwidth of performance. Here’s the additional feedback that we have. Here’s the research that we’ve done with our customers about whether they think that we are providing a decent customer experience," and trying to look at the issues through several different prisms.

Those discussions went on regularly, and I would meet the leaders of the bank and talk about our worries about the business being managed through incentive schemes as opposed to a more balanced approach. Over the years that I have been involved, we have got better outcomes on some occasions and in some periods from a balanced scorecard approach to performance management, rather than-

Q283 Chair: At what level did you talk to the bank?

Ged Nichols: Up to chief executive level. Indeed, I had meetings with the chairman and deputy chairman of HBOS and talked about such issues.

Q284 Mark Garnier: Did you at any point flag up, before it became a scandal, that PPI was a potential problem either because a product was being mis-sold or because the attached incentive scheme was too aggressive?

Ged Nichols: Taking the second point first, there was no incentive scheme specifically linked to PPI.

Q285 Mark Garnier: So it was just another product.

Ged Nichols: Yes. In terms of our ability to do some kind of audit on whether a product was appropriate, we do not have that capability or power.

Q286 Mark Garnier: What I am trying to understand is whether, during the course of this process, which was quite efficient in terms of trying to work out what was going on, anybody raised the fact that they were unsure as to whether PPI was suitable for the customers to whom it was being sold.

Ged Nichols: I do not recall that coming directly through union channels, but do not forget that we had had pensions mis-selling, endowment mis-selling and bank charges. There was a perception among some people that whenever one particular stream of income for the claimant management companies on bank charges would dry up, they would find the next one, which is why there is already speculation about what the next one is after PPI, because people are making an awful lot of money out of dealing with the claims.

Stuart Davies: There is a real issue here in terms of the consumers that are actually impacted. If you look at the structure of the banks, they have wealth divisions that look after their high-earning customers, who have an individual relationship with a relationship manager and get a high level of service. It is the same with private banking and with independent financial advisers. They get this one-to-one, high level of advice and support. However, if you look at the branch network and the mass of customers, that is where we are experiencing problems around several such products.

Across the finance industry, Unite meets senior individuals of the banks-the managing directors of the retail branch networks and the managing directors of the actual divisions-to raise our concerns about the whole position around product pushes in terms of there being specific campaigns around a particular product, whether that is mortgages one week or home insurance the next. We have made significant progress in the past five or six years in terms of reducing that level of pressure and there being a more positive approach to needs-based rather than product-based selling. The difficulty that we are into now is that we have made a lot of progress at senior and central levels with the organisations, but the culture, which has been so ingrained for so many years, is taking a long time to turn around. Even though centrally the employers are saying to us, "There are no longer any individual product targets or product pushes", at a more local level we find managers at area or regional level are communicating out to staff saying, "You must get x of that this week and you must get y of that this week, otherwise the consequences are a, b and c." They will then display on walls in branches that person a has sold so many, person b has sold so many and person c has sold so many.

Q287 Mark Garnier: Are any of these managers your members?

Stuart Davies: Yes.

Q288 Mark Garnier: Do you have any sort of internal system whereby, if a manager is pushing too hard, you can put sanctions on them?

Stuart Davies: This is one of the conversations we have. We are not a clerical union. A lot of these individuals are our members and when we raise these issues, we are careful to frame it in the sense that they are our members and that we are not on a witch hunt. We want the agreements that we reach centrally with the employer to be disseminated and imposed correctly at a local level. We will raise individual issues. When those issues are raised, the bank will deal with those.

Our concern is on, with every one that is raised, how many are going unchecked. That is where we have this disconnect between what is agreed centrally and what is implemented at a local level, and that pressure remains among the staff. If you look at the retail branch environment, proportionally you are more likely to be an underperformer working in the retail branch environment than in any other area of the bank. You are also more likely to be disciplined working in a retail branch environment than in any other area of the bank. That is because of the sales culture, not because those people are less talented.

Q289 Mark Garnier: Is that because of unrealistic targets?

Stuart Davies: Correct. There is one example in one of the banks where at a point only one in 12 staff members were achieving 100% of the targets. Our argument was very much-

Q290 Mark Garnier: The targets are wrong.

Stuart Davies: Absolutely. That was a difficult argument, but, again, you would say, if people are being put under pressure and were-

Q291 Mark Garnier: That is a significant point, because if you are asking a sprinter to do an eight-minute 100m-sorry, even I can do an eight-minute 100m; I meant an eight-second 100m-that is clearly a ridiculous target. What you are saying is that these targets were set way, way, way too high and therefore could only promote bad practice.

Stuart Davies: Indeed. What came as a result of that was a blanket instruction that went out to say that everyone who was less than 80% of target must be put on performance management procedures, with no investigation into the circumstances under which those individuals were underperforming and with no sense of the fact that if two out of 10 are not achieving target, the target might be about right, but if only one out of 12 are achieving it, there is clearly something fundamentally wrong with the target. We have made great progress on that, but we are still encountering issues around unreasonable and unrealistic targets.

Q292 Mark Garnier: So they are still in place.

Stuart Davies: Indeed.

Dominic Hook: There are still banks today with notice boards on the wall that list all the individuals, with what they have sold in the past week and who is top and who is bottom. There are also e-mails going out in different colours-who is red and who is green. It is that pressure on staff that makes them stressed. There is also a rigid sticking to a bell curve. If you have a team of 10 people, you may have a target of 5% being a good performer and 5% being a poor performer. No matter what the targets are, you know that one or two people will be a poor performer. It creates a lot of stress and means that the pressure on them to mis-sell or to be in circumstances where mis-selling can happen is much greater. We think that it is a cultural thing that comes right from the top of any organisation. It takes a long time to change the culture of an organisation, but it is the culture that is doing it.

Q293 Mark Garnier: What evidence do you have that it is coming from the top and not from a thrusting regional or branch manager?

Dominic Hook: Because it is too widespread.

Q294 Mark Garnier: So when you talk to colleagues in different regions, you are getting the same message back, in the same way that you described earlier.

Dominic Hook: People are not acting in the same way and saying exactly the same things, but it is the same pressure right across the board, from managers right down to the front-line staff receiving that pressure.

Stuart Davies: I think the veracity of the cultural change is not being implemented forcefully enough. It is not being embedded as well as it should, so you still have individual managers at a reasonably senior level who cannot divorce themselves from the rigid approach of, "How many have you sold? How many of these have you sold? How many of this product have you sold?" It is about how the employer is. We quite often speak to the employers we deal with and say, "You have to be explicit. You need to be making very explicit statements about what is acceptable and what is not," because any ambiguity is left open to misinterpretation, and we have individuals who fall back to the old culture of selling by product rather than by need. That is obviously central to treating customers fairly.

Q295 Mark Garnier: One last question: is there a point at which you can identify that an old, traditional culture changed into this culture that you are describing, and if so, when was it?

Stuart Davies: I think the crash focused a lot of minds, and that gave rise to a cultural change.

Q296 Mark Garnier: For the worse?

Stuart Davies: For the better.

Q297 Mark Garnier: No, I am thinking about when it went from good to bad.

Stuart Davies: Oh. Like Ged, I used to work in the finance sector myself-Midland bank and HSBC-and certainly when I worked at HSBC in the mid-’90s there were no sales targets for staff. Towards the end of the ’90s you started to get explicit sales targets that you had to achieve. The consequences of not achieving them linked into performance-related pay, where if you did not achieve, you did not get a pay rise or a bonus, were possibly disciplined, were more likely to be selected for redundancy and obviously were likely to be dismissed for underperformance. So the late ’90s is where that started to take shape.

Ged Nichols: I would add to that the issue of the banks shifting their remuneration policies away from fixed pay, salaries and salary increments, towards variable pay, bonuses and performance-related pay. That did not change behaviours immediately, and there was a time when, in many ways, it did not seem to be a bad thing. However, through economic changes-an extended period of low inflation, low wage growth-there was more emphasis on incentives. For people further up the hierarchy the level of incentive payment increased, so if you were managing a sales team, you would get a higher proportion of variable pay than your salesmen got. That is where the pressure started to really increase. Thankfully, that is no longer possible under new regulations, but as the proportion of variable pay got higher further up the organisation, they therefore brought more pressure down.

Q298 Chair: The e-mail that you sent us with your written evidence mentions advisers who fail to deliver mortgage applications. It says that one mortgage needs to be done between Friday and Thursday each week. If it is not done, "documented coaching" takes place. If it is not done for a second week, the branch manager will try to understand the "root cause" and identify the "need for change". If it is not done for a third week, "further action will be taken with HR guidance with both the adviser and Branch Manager in order to support the business with delivery of this key goal." Is that an outlier-type e-mail, or would that be typical of the pressure that your members were under?

Stuart Davies: It is not condoned centrally, so it raised issues and they are dealt with. The difficulty is that, as we said in our evidence, although these examples are not true for a majority of workplaces, they were in a significant minority, so it was still way too prevalent.

Q299 Chair: It was pervasive.

Stuart Davies: Absolutely.

Dominic Hook: It is a typical example.

Q300 Mr McFadden: I want to go a little further into the incentives that you were just talking about, Ged. I am trying to get clear in my mind the balance between carrot and stick for front-line staff engaged in selling PPI at the height of things, which was probably 2004 to 2007, or something like that. What difference would hitting sales targets or selling a lot of these products have made to the typical staff member we see when we go into a branch?

Ged Nichols: Let me try to put some numbers against it in today’s terms to try to illustrate this. For the people who were selling PPI, alongside a range of other products, the mid-point of their salary level would be, currently, just under £20,000. They are paid below the national average wage.

Q301 Mr McFadden: That is basic pay?

Ged Nichols: That is basic pay. Their on-target bonuses, which would be paid quarterly, would be-in HBOS terms, before the takeover-about 12% of salary, but there was no upper end on that. So you had to achieve something like 80% of your target to get any bonus at all, and if you were on target, you would get around 12%. If you exceeded your target, there was not a cap, but realistically what somebody could earn if they were behaving properly-there were other checks on customer satisfaction and on what we would now call compliance issues before bonuses were paid. That was the quantum for people on still relatively modest salaries to get a quarterly incentive payment, which for most of them would have been between £500 and £1,000 a quarter. It is probably less now. In fact, I have got the figures in front of me for the average incentive payments that were made in the last quarter of 2012.

The further up the ladder you went, when you get up to regional management 50% of their pay was variable pay. They were incentivised through long-term and short-term incentive schemes linked to bonuses as well. It is almost like pyramid selling, in effect. In previous years, going back some way, there would have been an annual bonus payment from the bank and everybody would have got the same percentage of their salary. When you start building in that if the staff are getting 12%, the branch manager is getting 20%, the local director is picking up 35% and the regional director is picking up 50%-I have just used those figures illustratively, by the way-you can see where the pressure is going to come from somebody to say to a range of branches that they are managing, "You have got to hit the numbers, because I have got a 50% bonus riding on this."

If that 50% bonus could be used to buy shares, that would be tax free in three years’ time. Before the collapse in banking, people had considerable sums of money tied up in bank shares because they would not take their bonuses in cash and suffer tax on them, because their salaries were high enough anyway to live on. At the bottom end, people were supplementing poor salaries by incentive payments. At the top end, people were using the incentive payments to put into share incentive schemes, and driving everybody’s behaviour because there were enormous amounts of money available to them. Was this culture designed in to the whole remuneration structure? Yes, it was.

Q302 Mr McFadden: Okay. I am quite interested in that. That is the carrot side, if you like, of bonuses and money. What about the stick side? Unite talked about how if you did not hit the targets, you would start to be performance-managed. People would tap on your shoulder and say, "What is going wrong here?" Can you talk about that for a minute? If there was an incentive money-wise to sell the products, what was the pressure side of this? What was the stick side of this if people did not sell?

Stuart Davies: The management would identify at an early stage whether somebody was not performing against their sales targets, whether that was points or products. That would manifest itself into a performance improvement plan to improve performance and reach required levels of sales. If that did not lead to the correct level of performance, disciplinary action would follow. That would lead its way through, potentially, ultimately to dismissal.

Q303 Mr McFadden: You have members who were ultimately dismissed?

Stuart Davies: For failure to achieve sales targets, correct. A consequence of that was that you would be classed as an underperformer, and under the performance-related pay system, you would receive no pay rise and no bonus. You would have an ever-diminishing remuneration in respect of your so-called underperformance, despite the fact that you might be delivering a first-class customer service to the customers who are coming through the door, because you are not achieving the products and the sales and the points, and that would lead itself into performance management.

Q304 Mr McFadden: I want to probe this a little bit. Although obviously PPI was oversold and everybody recognises that, to play devil’s advocate, selling products and doing business is what a bank is there for. In a way I can see why a bank would become concerned about a staff member who was not doing any of that: if there is a mortgage adviser who never sells a mortgage, you can see why a bank would start to get concerned. How do you judge a sensible balance between doing the job and crossing a line where sales become the only thing that matters, which is when alarm bells start ringing?

Stuart Davies: The point that I would make to you about the employers we deal with is that, aside from some honourable exceptions, none of our members goes into work not to do a good job. So if they are dealing with a customer and they identify a specific need that that customer has, they will sell to that need. They have no difficulty with that whatever. The problem comes when they are being pressurised to sell-being told that they should be cross-selling three, four or five products to their customers. The banks now talk a lot about main bank customers, so if we are the bank into which your salary is paid and from which your direct debits are sent, we should be cross-selling on a number of areas, whether that is packaged accounts, saving accounts, loans, credit cards or home insurance, and so on and so forth.

There will be occasions where genuine performance management issues arise. The difficulty we have, coming back to my previous point, is that if you compare certain parts of the organisation where the jobs are commensurate on wage, grade and benefits, you are more likely to be classed as an underperformer and be disciplined for performance in a retail branch environment than you are in any other banking environment within the organisations we deal with. To my mind, that says that there is a direct correlation between the sales culture and what is expected, sales wise, that leads into a punitive culture around underperformance and discipline.

Q305 Mr McFadden: You talked about how things had changed after the banking collapse of five or six years ago. I want to ask a little about that in terms of sales incentives. We have had a number of announcements from banks in the past six months or so, saying that they are changing their front-line sales incentives, that they will get rid of sales commission and so on, and that it is all about customer care. At a different panel we had branch managers from some of the leading high street banks who all said that five years ago it was an entirely sales-driven culture but it has changed today. I want to explore that with you.

Dominic Hook: That is interesting because we have examples from banks today that have what they call whiteboards, which is basically a board on the wall that lists members of staff and the products that they have sold right there for everyone to see. So they might not be saying that there is an incentive for that, but there is a reverse incentive to not get the numbers up, because otherwise you are at the bottom of the board and not the top, and that affects everything for you as an individual-your pay, your discipline history and all the rest of it.

Q306 Mr McFadden: It is like that thing on "Top Gear" about who can drive round the track the fastest.

Stuart Davies: Absolutely. They will have it split down by each individual product: how many mortgages, how much home insurance, how many loans, how many credit cards. We have posed this question on a number of occasions to a number of banks and have not to this day received a satisfactory response as to how on earth displaying that information on the wall of a branch, so that all your colleagues can see who has performed well-bear in mind the fact that it is available to managers to manage, support, train and coach their staff-motivates employees to sell or motivates them to good performance.

Q307 Mr McFadden: I suppose it could motivate them to sell-but in the wrong way.

Stuart Davies: Indeed. We see it very much as a naming and shaming exercise, to make people feel uneasy and say to themselves, "I actually need to up my game here." That could potentially manifest itself in dysfunctional behaviour. The point that Dominic makes is quite right: they may have removed the sales element from a number of incentive plans, but it still sits behind as a performance indicator when it comes to whether you are deemed to be a good performer or an underperformer and whether you are therefore disciplined-no pay rise, no bonus and so on.

Q308 Mr McFadden: I want to finish by putting this to you, and then I will come to you in a second, Ged: are you saying that the culture has changed in terms of the pressures on sales or that these changes are cosmetic and it has not really changed?

Stuart Davies: It has improved, but there is still a long way to go.

Q309 Mr McFadden: Ged, can I ask you to take us through the change in those front-line incentives you spoke about a few minutes ago? What has happened in Lloyds HBOS?

Ged Nichols: On the previous point, it seems that there is a little less carrot and a bit more stick post-2008, and the culture is changing. Dominic and Stuart were right in that it takes time. Banking used to be a self-contained discipline, but people have now been brought in from retail and all kinds of other organisations because they were trying to change culture in a certain way. So there are managers in positions, not always at branch manager level, but above that, who were brought in to be sales managers and that is all they know what to do. So it will take time to change the culture.

In HBOS and Lloyds Banking Group, the incentive schemes have changed to increase the level of the proportion of the incentive that is payable for service, and there is a quality or risk hurdle in all the bonus schemes. So it is not just about sales; it is about checking with customers whether they feel they have been properly served, checking whether the paperwork has been done properly and that the appropriate product was sold. The bonus schemes have changed significantly from the start of this year.

I echo the point that the culture change is not being felt by everybody in all branches yet. When you try to change behaviours in 1,000 branches for 1,000 managers, some of them take longer than others to get it. The language has changed, but not all the behaviour yet. But I would certainly say that it is now on a better path.

Q310 Mr Love: Following on from that, I am not yet clear as to the role of the branch manager or the regional manager in relation to the payment of bonuses, either before or after. Presumably incentive plans are written down so that all the staff know what they have to do to achieve their target. What flexibility does the manager have at a local branch to vary that? I am talking about someone who ticks all the boxes of the written incentive plan, but the manager says, "You have not come up to scratch; I’m not going to pay you the full bonus."

Ged Nichols: In my experience, relatively little. Things are not managed at branch level. In the past there have been balancing items for local or regional directors for the incentives to be paid. It would not be just on sales. For example, they would be double-checked against the colleague engagement surveys that would be taking place to ask staff whether they felt they were selling to customer need or product pushing. That would be investigated, and some of the risk in compliance work would be cross-checked as well.

If I have given the impression, and I may have done, that there were absolutely unfettered sales arrangements that had no balance in them throughout this period, that is not exactly what I meant to say. But in terms of the way the businesses are managed, there is relatively little discretion for a branch manager to vary targets. Targets are set at national level. We think one thing you could do is to have team-based targets at branches so that you build in co-operation among the work force and people are seeing the different interests and needs of the customers, rather than staff competing against one another. Unfortunately, some of the individualised incentive arrangements create that by-product. Nobody then wants to see a customer where there will not be a sale, or where there is not a points-based interface with the customer. They want to cherry-pick the customers from whom they will earn bonuses or points, as opposed to looking after all of the customers’ needs in the interests of the bank, the customer and the business. We think that good incentive schemes should be designed around customer outcomes and doing the right thing, as opposed to just hitting numbers.

Q311 Mr Love: Let me come back in a second to the team-based idea. You are telling me that in the previous scheme, and now as we develop the new schemes, service was always a component quality, as was sales.

Ged Nichols: There are greater proportions now.

Q312 Mr Love: Yes. That is what I am trying to get at. We had witnesses before us from branch and regional levels who said that it had changed completely and sales are now excluded from the consideration, and it is now all about customer-focused activity. That clearly is not the case, from what you are saying. What change in the balance has occurred? Is it an ongoing process? Is it going to continue?

Ged Nichols: Yes, it going to continue to be reviewed. The customer service level in the current incentive arrangements for branch staff has increased to 50%. It was not 50% before. It would have varied, depending on whatever the customer service measure was over the past 10 years or so. But for 2013, it is 50% customer service.

Q313 Mr Love: Is your experience the same in Unite? What role do sales targets have now?

Stuart Davies: Some of the banks, in fairness, always had a service element within the incentive plan. As Ged quite rightly said, it is shifting towards a more equal share of the two, and 50% tends to be typical. They now tend to look at the sales element more as a contribution-how much contribution comes in to the individual branch-rather than "points means prizes". The bonus is therefore driven off the amount of income that has come in, rather than saying, "You sold X amount of these and X amount of those." The difficulty with that is the design of the incentive plan is inconsistent with the design of objectives and performance management. They do not correlate with each other, so you have two competing strands. The incentive plan itself appears to be more holistic, whereas the performance management trend is still about what a person has done individually to achieve the overall goals of the branch.

Dominic Hook: So there is no incentive-perhaps-for sales. Instead there is a disincentive in terms of how you are performance managed. You are more likely to be disciplined for not selling products, but you will not get any of the incentives you might have got before. That is the trend in many places.

Q314 Mr Love: That is the question I was going to ask. How much management focus goes into each of these different components. Although sales now have a lesser function, in terms of the overall targets that members of staff are being asked to achieve, is the management focus on ensuring that sales are kept up?

Stuart Davies: In the perennial debate we have with the employers, we argue that if the banks-and therefore our members-provide excellent customer service, sales will be derived from that service. Customers who require a loan, a credit card or a mortgage are more likely to go to a bank where they have received great customer service. The banks tend to have a slightly different view. They think that actually selling to people’s needs is, in itself, great customer service. So they have a slightly reversed view of how customer service works. A lot of our members subscribe to our view that if they provide great customer service, customers are more likely to come back and more likely to recommend them to their colleagues. As I say, the employers have a slightly different take.

Q315 Mr Love: One final question, returning to the idea of working as a team, rather than individually, at branch level. What interaction is there between management and the staff about how the incentive plans are structured? What support are management giving to increase the level of knowledge of staff about the products they are selling in order to ensure that they can provide the customer service that everybody talks about?

Ged Nichols: One of the issues has been the greater specialisation within the make-up of a branch team. When I was a boy, everybody would take their turn in the different roles in the office. Now you often have specialised sellers of products that are regulated to a different degree. So it is inevitable that your mortgage adviser will be doing something different from a financial consultant, who will be doing something different from a banking adviser. There are specialists within the sales team.

I guess it is how you ensure that everybody is working together to ensure the customers get what they want and need and that people share collectively and jointly in the reward for that, so that you are building some sense of community both within the staff and within the local community itself. You are there to provide services. You are not there to enrich individuals, whether those individuals happen to work in the local branch or happen to be the regional or local director with responsibility for the branch. So it is back to what banking is all about in my view.

At a time when banking is under scrutiny, and rightly so, given the damage that was done, I find it very strange that we have got payday loan companies charging 4,000% interest a year. There are people who find it easier to do business with payday loan companies than with banks. That is a terrible indictment and it is going to cause all sorts of social problems. If the banks cannot get back to serving communities, even the less well off people in the communities, leaving them prey to payday loan companies, all manner of problems will manifest themselves before long.

Q316 Chair: The British Bankers Association undertook the judicial inquiry in 2010. Angela Knight, the former BBA chief executive, was before us last week and she said that she was personally against that. She was very firm on that, but the BBA went ahead. When that went ahead, did the union have any concerns about that or did you speak to anyone about it?

Ged Nichols: I did not personally see that that was an industrial relations matter, which is what we are principally there to deal with. Again, when you are talking about 2010, we would have been dealing with the major fallout with HBOS getting into difficulties and being taken over by Lloyds TSB and all the job losses and other issues that came out of that.

Q317 Chair: The main remit that we have as a Commission is to examine the culture and standards in the banking industry. Before you leave us, are there any issues that you want to impress upon us as we write this report?

Dominic Hook: One of the things that is really important to our members is how they are paid. That is an important part of the culture. Performance-related pay is very popular among the people who do well out of it, and, of course, it is very unpopular among the people who do badly out of it. There is lots of evidence that the pay gap between men and women in financial services is much bigger than anywhere else, and I think that that has a lot to do with the pay systems that are in place. So what we need is transparent pay systems that are open so that everyone can understand them. The other side of that is that we strongly believe that there should be representation for employees on the remuneration committees of highly paid and senior executives, because that completes the circle of how people are paid.

Q318 Mr Love: Do you think there should be a cap on performance earnings?

Dominic Hook: Yes.

Q319 Mr Love: Have you thought about what that should be?

Dominic Hook: No.

Stuart Davies: As a trade union, we support fixed pay rather than variable pay. We would much rather see high levels of basic pay, supplemented by more modest incentives, than a situation in which low salaries are having to be supplemented by higher bonuses. What we certainly saw with the crash was that when bonuses were retracted because of the difficulties that the organisations faced at the time of the financial crisis, this over-reliance on incentive and bonus left people in a precarious situation because their base pay was not sufficient to survive on. There was an over-reliance on bonuses-my view is that a bonus is a bonus which should be used to pay for a holiday, buy a new car or get a new three-piece suite, not to supplement your day-to-day bills. That is where bonus incentive has begun to come around to: higher, fixed base pay rather than a reliance on variable pay.

Ged Nichols: From my point of view, I will say that we were delighted to get the opportunity to speak to the Commission because the voices of ordinary bank workers have not been heard in all that has been said and printed. I assure you that bank workers are every bit as angry and upset about the banking collapse and the damage that was done, and they are very conscious of the need to rebuild trust and confidence in the banking system and pride in their employers.

When we talk about these issues, there is a danger that the work force, through a reduction in their total earnings, start to bear the brunt of the consequences of organisational change, organisational culture, management behaviour and public anger, and that we make the ordinary workers worse off by introducing regulation on incentives. So, when the incentives themselves have been a substitute for fixed pay over an extended period, the work force are very worried that we end up with the unintended consequences that the lowest-paid staff have to give up proportions of their total earnings while, when things return to normal, reward at the top will be as it ever was.

Q320 Chair: Sure. We were conscious that that voice had not been heard, which is the reason why you were invited here today. I have had many ordinary branch personnel speaking to me over the years who mentioned that they have given service of 30 or 40 years, but, because of the shares incentive, they are a lot poorer now as a result of that. Their view of what has gone on is every bit as trenchant as the ordinary public’s view. We appreciate that, and we thank you for your attendance today. You have been very helpful.

Examination of Witnesses

Witnesses: Paul Geddes, Chief Executive of Direct Line Group, RBS, 2009-present and CEO of UK Retail Banking, RBS, 2006-09, Gordon Pell, Chairman, Retail Banking and Wealth Management, and Chief Executive, Retail Markets, RBS, 2002-07, and Guy Whittaker, Group CFO, RBS, 2006-09, examined.

Q321 Chair: Welcome to our session on mis-selling, and thank you for coming along. We have Lord Turnbull and myself from the Lords and Andy, Pat and Mark from the Commons, and we have our counsel, Adam Tolley, who will come in at a later stage.

I will start by asking about the PPI situation. The costs of PPI mis-selling are increasing almost by the week. A report in The Times this week talked about £25 billion. Another report talked about £40 billion, so who knows where it will end up. Both the cost and the time scale, which have been generational, are really damaging to financial stability and one of the reasons that we want to look at that is to ask the questions of how we got here and how we ensure that this never happens again. Why was such a product, which offered such poor value-particularly the single premium products-designed and sold? Maybe if we have an historical sweep and then you can help us.

Gordon Pell: Since I have had the longest history, perhaps I can start. I start, though, by saying that I am three years into retirement. Obviously, I watch the exercise going through in the press and it has been fundamentally dispiriting, to put it mildly. I have had a chance to reflect on what happened, and before we start I want to add my own personal regret to that already expressed by RBS. Following the clarification of sales standards after judicial review, RBS concluded that a material number of these policies had been mis-sold. I am absolutely certain that, during this period, I and the 40,000 people who worked for me acted in good faith, but that does not avoid the fact that significant costs have come through and that a massive damage to banks’ reputations has occurred, which, after 40 years, I take very seriously. I am also particularly concerned from a personal point of view about what I thought was an open and constructive relationship with the regulator. At the end of the day, it proved to be relatively ineffective at avoiding this situation.

On a history of this, loan repayment insurance, which is the term I prefer to use, has been around for about 25 years in one way, shape or form. At the end of the day, it has been looked at by a number of bodies, and everyone has concluded that there is a real role for insurance to cover the repayment of a loan for certain customers-I emphasise that point-particularly those who have relatively low income in relation to the loan, or one income or other outside liabilities. There are clearly a number of customers for whom this is the right product. The product itself, although it has gone backwards and forward, has not changed dramatically in shape during most of my 20 years and, for most of that time, it has been relatively uncontroversial. There are a number of periods one ought to look at in terms of how this has changed, the interaction with the regulator and the various bodies that we rely on to give us early warnings of trouble quite outside our internal controls. We obviously have to listen to both internal and external feedback.

Up to probably 2003, I would honestly say that the product was relatively uncontroversial. There were obviously issues on and off over the years, but there was very little customer complaint. The Financial Ombudsman Service continued to find that up to 80% of the relatively limited number of cases that actually went through to it went in favour of the banks. As we moved through to 2005 and 2006, the FSA became engaged under its new responsibility. We work with them responsibly and constructively. To some extent we were both working our way through a new process, and we worked with them extensively to look, essentially, at the sales process. If there is a criticism of both of us, quite frankly, it is that we were tending to look at the foundations of the house and how we could work on it, rather than at the house itself.

Clearly, somewhere in late 2007, and probably even at the beginning of 2008, the temperature changed dramatically, in terms of the numbers of complaints that went to the Financial Ombudsman Service, which went up dramatically. There was an almost seminal day, which I cannot actually identify, where, from 80% of complaints being found in our favour, 80% were being found against us. In that sort of situation, you really have no choice but to look seriously at whether the product has a sensible place in your portfolio in the future. In terms of helping to guide the Commission towards a date-a clear point on which we could all focus-that is the date. In retrospect, you could argue that it was building up over time, but that was when the indicators began to move from green to flashing amber.

At that point, clearly we moved into a situation, from 2007 onwards, where the banks and the FSA were in active discussion as to where we went from there. My responsibilities tended to move to group, rather than direct, management of the banking businesses, but I still received reports from what was happening at regular discussions. From my point of view, by that point, we had sort of passed the point of no return as an industry. I deeply regret that I had not found some way to extricate RBS from this exercise. It would have been difficult, but, somewhere around ’07, although my responsibility at the end of the day was for RBS alone, was there a way for one organisation to somehow change the ground rules? I have thought about this a lot, and I actually do not think that there was. At that point, we had all passed the point of no return.

I emphasise the joint responsibility of ourselves and the regulator. Once you start getting involved in multi-bank, regular-type steering committees, time scales inevitably tend to extend, and in this situation, time actually matters. I was delighted to see Martin Wheatley’s comments that the new FCA approach will be very much about tackling issues head on and necessarily tackling issues without evidence. You need a mature discussion between senior bank management and the regulators. When you reach this point, it is absolutely vital that you get a quick resolution, so that you can limit the damage. Part of the problem we have here is that the issue ran on. I am now three years into retirement and the issue is still running on. I think I was two years into retirement before the FSA actually came up with a final, final view on what the situation was. Maybe I should involve Paul Geddes in this, because he was involved towards the later end of the exercise.

Paul Geddes: I am Paul Geddes. I joined the bank in 2004, and my responsibilities were for the products and their marketing. I sat alongside someone who ran the branch network, reporting to a chief executive who worked for Gordon. I was promoted in 2007, when I assumed responsibility for both the branches and the products, reporting to someone else who reported to Gordon. I then left the bank, or got promoted to run the insurance business, which was initially part of RBS but this year is listed as a separate company under the name Direct Line Group. I guess I have a very interesting perspective on this chronicle all the way through the various periods that Gordon mentioned and, indeed, into the future, as we reflect on what the multiple learnings are from this sad chain of events.

If it would help the Commission, I would like to speak about the various phases and how we saw these events unfolding. When I joined the business, the sniff test of this product, which is something you do, did not suggest particular problems in itself. Was this a product customers had need of? I do not need to remind the Commission of the fact that most people have low levels of savings and a low-level ability to cover unforeseen events. Therefore, when someone is going from an unsecured lending product to a mortgage, thinking through what would happen in certain events and to have something to protect them is certainly a product need. During this period, the bank was selling to about half the people.

The other tests that one would apply to customers include: was the customer satisfied with the product; were complaint rates normal, which they were with the FOS generally; were they satisfied with the bank; were the sorts of customers who were buying this product the ones whom we would expect? We looked and saw that the penetration of the product was highest among people who had a less certain income, so professional salesmen had one of the highest penetration rates of this product, and civil servants and people with much more steady sources of income had much lower penetration rates, so that seemed to work. We contacted customers and they seemed to be satisfied with the product.

Through this period, and as the FSA picked up the regulation in 2005, this was a BAU-nature of interaction with the regulator. The regulator found opportunities for the sales process to be improved, which we implemented. We found opportunities for the product to be improved. We prided ourselves on having what we thought was the best product in the marketplace. In my products and marketing role, consistent with our helpful banking positioning, we took out exclusions-pre-existing medical evidence, to be one key example-and we improved the sales process, some of the things bilaterally. We made sure that the person talking to the customer would go through the features of the product. Some things were asked by the FSA, and we fully complied with what the FSA wanted.

Just to wind forward a little bit, in line with Gordon’s comments. In the late 2007-08 period, it became clear that the FSA’s burden of proof of what was an acceptable sale was something that would be very hard to achieve. As a result of that, at the end of 2008, Gordon and I elected to take the product off sale. In that period of time, the expectations of what was an acceptable sale were stepped up, and it became evident from the conversations in 2008 that the verbal disclosures that we had to disclose to the customer were ahead of what we had been told to do before, and the standards of evidence of that verbal disclosure were ones that we thought would be practically difficult to hit.

So I took the product off sale and volunteered to the FSA a past business review, which is to write to customers and see whether they bought it for the right reasons, the wrong reasons, and whether they had problems with the product, so we could remediate. That process we were unable to find-I left the bank at this stage and worked in insurance, but my understanding is that the process led to a lack of agreement between us and the FSA of what an acceptable standard was, which latterly led to the JR and to the publishing of the standards in 2010 of what an acceptable process was.

I guess I tell the story in this way to say a couple of things. One is that through the evidence that we saw in the various stages, I believe, and I have examined my conscience, that we acted in good faith. Clearly, the elongated process of changing views of what good practice was all the way through to the JR was over a very long period, during which time bad things happened. Clearly, the bill got a lot bigger. Lots of trust in the sector was poor and there are definitely learnings to be had on many fronts, including the time it took for this to be properly resolved.

Q322 Lord Turnbull: When you took it off sale, were you the first in the pack?

Paul Geddes: I think that we were in the following pack. I think that HSBC for its own reasons chose to take the product off sale earlier.

Q323 Lord Turnbull: Mr Pell, you said that you look at the foundation of the problem from the sales process. I do not think that that is where the foundations are. I think that they lie in the design of the product. Presumably, the people who designed the product-certainly you, Mr Geddes, and possibly you, Mr Pell-must have known that quite a number of exclusions were written into these contracts.

Paul Geddes: We had no desire to have unhappy customers. The basis of our strategy, Helpful Banking, which really helped NatWest, in particular over this time, to increase its customer satisfaction and its market share, and the basis, I think, of a good business was not to be in dispute with customers, so I looked at all the key exclusions that were causing claims to be contested and we took virtually all of them out. I’m talking about pre-existing medical back pain, psychological issues-we had five years’ worth of cover for disability and most of our competitors did, too. We paid out 88% of claims, which I believe is the highest percentage in the industry.

Q324 Lord Turnbull: But around the period from 2005 to 2007, that number would have been more like 15%, wouldn’t it? I am talking about what you were paying out.

Paul Geddes: Sorry, my data was just the percentage of claims submitted that we honoured. It was 88%.

Q325 Lord Turnbull: Not the percentage of premium paid out.

Paul Geddes: Indeed. It may be worth saying how we looked at the profitability of this product. I think it is fair to say we saw the profitability of this product integrally with the profitability of personal unsecured lending, and in aggregate the returns were not high.

Q326 Lord Turnbull: Yes, but that is the whole point-in aggregate. I would contend that you sold a product to people, many of whom could not claim, and you made a very large margin on that. You were paying out only about 15% of premium. Once that was under judicial review-what we were told by the Competition Commission was that the excess over the cost of capital was something like £1.2 billion in 2006. Let’s call that the excess profit. A large part of that is used to subsidise the interest, but the detriment to the consumer overall is much smaller-say £200 million or £300 million. But, as a result of your supporting the JR, you are now paying back something related to the gross premium and you are not getting back the subsidy, so you are going to pay back more than you ever won, as a result of your slowness in resolving the issue.

Paul Geddes: I cannot really comment for the period post-2009. I will just say in terms of how we saw the profitability, though, that we did see the fact that customers were effectively buying a protected loan. The Competition Commission took a different view.

Q327 Lord Turnbull: Surely the people designing the product were sophisticated enough to know that there were quite important groups who should not be buying it. What seems to have happened is that they did not take sufficient steps to make sure that at the front line, in the branches, people adequately sifted those through and excluded those people.

Paul Geddes: With respect, we did two things. One was to remove people who were-pre-existing conditions and reasons to refute a claim. Our objective was to pay out as many claims as possible. In terms of the groups, if ever we found a group was buying the product that should not be buying it, we did a couple of things. I found, for example, that 5,000 of these policies had gone to people over 65 who were ineligible. In a heartbeat, we repaid those customers in full and told the FSA; we were not required to do that.

Q328 Lord Turnbull: Well, if you were doing that, all the mis-selling must have been in other banks.

Paul Geddes: No, I am saying that, clearly, what later emerged was that the evidential standards that were required of us, which were finally published at the end of 2010, were not the evidential standards as we understood them in 2005 and 2008, but I am not trying to deny that there weren’t-

Q329 Lord Turnbull: Isn’t that another way of saying that you did not take enough care to establish the evidence of who you were selling the product to and what their circumstances were and, as a result, you ended up selling it to large numbers of people who could not make claims?

Paul Geddes: As I said, our claims ratio was very high. Our sales process was very structured in making sure that the customer agreed they were eligible for the product. The evidential standards I am talking about-we believed, as an industry, that it was a case of showing people before they bought the product a form that set out the terms of the cancellations in particular. The FSA told us to put that in writing. Later, it also required that we should have put it as a verbal disclosure. That became evident in 2010, well after we had taken the product off sale.

Q330 Lord Turnbull: But the complaint about this product is not simply that you should have done things verbally; it is that a product was sold with a quite extraordinarily low payout compared with premium. If you sell something as an insurance company and you are only then paying back roughly 15% of premium, the prima facie evidence is that you are either overcharging for it or selling it to people who, at the time they bought it, could not make a claim.

Paul Geddes: To clarify, I certainly do not think it is the latter. We paid out 88% of claims that were requested. As I said, when it came to the view of the profitability, and this of course was a view that the Competition Commission-

Guy Whittaker: I think that to some extent, although your point is the right point to be making, the other side of selling PPI was that the margins on loans that were being sold at that time were lower than they would otherwise have been. I think that was the earlier point about the rebate. Now this issue has been settled through the judicial review process, that rebate-or what is now the redress-is being paid on the PPI side and the consumer, in effect, has also had the benefit during that time of considerably lower personal lending rates than would otherwise have been the case.

Q331 Lord Turnbull: It is not an adequate defence. Even supposing you had made a billion in excess of cost of capital and subsidised loans by that, the problem with it is that the net benefit wasn’t the same for everyone; that the people-pensioners, self-employed and so on-who bought this thing were losers from it. So it was an unfair system distributionally, even if you in total hadn’t made an unwarranted benefit from it.

Guy Whittaker: If I can share my perspective, the size and scale of this issue only manifested itself once the judicial review had reached its conclusion, which was in 2011. My time with RBS Group, as a member of the board and finance director, was from February 2006 to the third quarter of 2009. During that time-I assume that you have heard this from my colleagues-every effort was made internally to comply with all the standards that we understood we needed to comply with to sell that policy: internal standards; external standards; and the board was kept apprised of the thematic reviews that had taken place, and of the Competition Commission investigation that had taken place. While there was some feedback from risk and compliance, and from internal audit, that there were instances in one or two areas where this product may have been mis-sold, the general impression that RBS Group had at the time was that it was meeting all of the standards that it understood applied to it.

There is a third point around this, which is the issue of cross-subsidisation. You have mentioned it. Cross-subsidisation implies that you sell a product for a higher price than if the product was sold on a stand-alone basis. The evolution of the retail banking market in the UK over time into a free in-credit banking model therefore relies on cross-subsidisation. And it seems to me, regarding your point about who is paying and how much is being paid, that a much safer and indeed a much fairer system would be one where each of these products could be sold without the need for cross-subsidy, so that they were there on a stand-alone basis and customers could choose in an open and transparent manner among different providers.

Q332 Lord Turnbull: But a different cross-subsidisation is, say, printers and cartridges; it is the same people who buy the printers as buy the cartridges. In this case, the cross-subsidies had distribution effects; if the product was sold to a pensioner, they were a net loser out of that process.

Guy Whittaker: There are subsets of people who buy a higher priced product, which pays for lower or no-cost products that are provided to many people. Yes, that is model that we have today. As I say, I think a safer and fairer system would perhaps be one where-we have heard lots of conversations around incentives and alignments, they would be better aligned-

Q333 Lord Turnbull: Did you ever ask yourself the Nick Leeson question, that the margins we are earning on this are too good to be true? If we had had a red team and a blue team, the red team might say, "Here is the product, I will design it", and the blue team saying, "Would I ever buy it?"

Guy Whittaker: In terms of context, from my perspective at the group, if the retail bank in the UK was around 20% of group revenues and, within that, the PPI product was about 5%, so PPI was a little over 1% of the group revenues, I would have tended to look at the retail banking in the round, which at the time-

Q334 Lord Turnbull: Can you express that in terms of profit? What percentage of the retail business profit?

Guy Whittaker: In terms of profit, the retail bank at the time, if I recall, was making around £1.5 billion to £2 billion, on a pre-tax operating profit basis. Within that-

Q335 Lord Turnbull: Your PPI profit-

Guy Whittaker: I might need some help from my colleagues on the detail of the PPI product. It is a few years ago and there have been a lot of products in the time, but roughly 15% to 20% claims and £350 million of income so-

Paul Geddes: About £300 million, maybe.

Guy Whittaker: Three hundred million pounds or so-that would be the right order of magnitude, yes, on that particular product. As an overall return on capital for retail banking in the UK at that time, it would be something in the order of 12% or 13%, on an after-tax basis, which was probably just slightly above the overall cost of capital-

Q336 Lord Turnbull: One per cent. of the retail division’s profit was the profit on PPI.

Paul Geddes: If you want it expressed as income, we can quickly come back to you on that.

Gordon Pell: I agree with that. Often you hear this figure of income expressed then as a facility profit, and you really have to get to the actual profit on PPI, which has to take into account the huge selling cost-as you have heard from union representatives-because 40,000 people dealing with tens of thousands of interfaces a day is a very laborious exercise.

Paul Geddes: May I just pick up one small point? When we found that some people over the age of 65 had bought this and could not claim, without question we did not want to make that sale, and it was the customer who ticked boxes to say that they were eligible. The intention to sell this product to someone who was ineligible was not part of the thinking. The cross-subsidy was within each credit grade-

Q337 Lord Turnbull: Once you found this pensioner, did you go back to all other pensioners?

Paul Geddes: Yes. Every time we saw evidence that we had sold to someone who was clearly ineligible we gave their money back. That was not our intention.

Q338 Lord Turnbull: That was not the question. Did you then go back to see all the other people who had not drawn it to your attention?

Paul Geddes: Yes. When we found it we worked out all the people over 65 that we had not refunded and we told the FSA.

Gordon Pell: May I touch on this issue? The issue of non-eligibility has sort of become the poster child of why this product was wrong. Non-eligibility is wrong, it is actually mis-selling. If a complaint was received on that category, it would have been dealt with, the person would have been refunded and we would have looked at the sales processes in the branch. That is absolutely clear. There is nothing terribly sophisticated about it, and we do not need the Competition Commission to tell us that that is wrong. Even now, I gather the number of complaints coming in-the benefit as a taxpayer now have come back after three years–that actually relate to non-eligibility is a very small number, and it has always been a very small number of the claims that have been made. I know it is quoted, and it is absolutely wrong, but at the end of the day we are talking tens of thousands of people dealing with hundreds of thousands of customers, so people will sometimes get it wrong. There is a form that you have to tick-that you are under 65 and in full-time employment-but sometimes those boxes clearly get ticked wrongly. We would refund with immediate effect, it would not even be a subject of discussion.

Q339 Chair: Mr Geddes, you took over as MD. When you took over, did you satisfy yourself as to the suitability of all products and do due diligence on them? Were you satisfied with your due diligence in PPI?

Paul Geddes: Yes, as I said before, a variety of factors influenced my judgment. We wrote frequently to customers who had bought the product. We looked at the amount of customers who cancelled, so through 2006 customers had a cooling-off period. We looked at the sort of customers who were buying it. As I said before, the product was heavily bought by people-

Q340 Chair: But you were satisfied that you had due diligence. That’s the question.

Paul Geddes: Yes, and I am saying it was through a range of filters, including complaints levels and a number of other factors.

Q341 Mark Garnier: Mr Whittaker, you said a few minutes ago that the free in-credit banking model simply does not make any money.

Guy Whittaker: No, it doesn’t.

Q342 Mark Garnier: It doesn’t. How many customers did you have-say, in 2006-with that sort of basic free in-credit models?

Guy Whittaker: The basic proposition in the UK for a retail bank account is that you do not pay for access to ATMs, your cheque account, payments to be made for direct debits, the cost of running a branch network and infrastructure. All of those things have to be paid for by something, so it does rely on other products being sold and then cross-subsidising that so that the overall business generates a return on capital for the risk inherent in that.

Q343 Mark Garnier: I am just asking how many customers you had at that time.

Guy Whittaker: Do you recall how many customers we had, Gordon?

Gordon Pell: Between 12 million and 13 million.

Guy Whittaker: It was around 22% of the UK current account market; that was with RBS at that time.

Q344 Mark Garnier: That is a key point. There is a lot of criticism that that money sitting in those bank accounts-presumably varying from £10 to several thousand, up to £100,000, although it is unlikely to be that-is not generating any interest, so you are making a bit of money out of that.

Guy Whittaker: It is part of the float.

Q345 Mark Garnier: But those funds are not costing you anything.

Guy Whittaker: Again, at that time, base rates were probably 5.5%. That was worth quite a lot of money. When the base rate is 0.5% that is worth considerably less.

Q346 Mark Garnier: Could you remember as the group treasurer at that time, how much money would be in those accounts, giving you that free funding?

Guy Whittaker: I was not the group treasurer at the time; I was the group finance director at the time.

Q347 Mark Garnier: Sorry, I’ve got you down as group treasurer. Sorry, for Citigroup.

Guy Whittaker: My time at Citibank was the previous 25 years where I ended up as group treasurer.

Q348 Mark Garnier: Would you have an idea? You were group finance director between 2006 and 2009. When you came in 2006, do you remember roughly what the amount of money would be in that free float?

Guy Whittaker: I don’t remember roughly. I know we could get the information about what those balances were.

Q349 Mark Garnier: It is going to be reasonably significant, isn’t it?

Guy Whittaker: It would be a reasonable sum of money but I would prefer that we get you the figures and provide them.

Q350 Mark Garnier: It is partly academic interest. The key point is that, aside from this income that you would be getting from that money just sitting in current accounts not earning interest, your entire business model on 12 million accounts revolves absolutely, as you have said, around selling other products. The business simply would not work unless you were using that access to 12 million people. You have got information of how much money they have in their accounts, what their spending habits are, what their turnover is. You have a huge amount of information on these individuals, the 12 million accounts. It absolutely requires you to sell other product in order to pay, as you said, for the branch network, the ATMs and so on.

Guy Whittaker: The main contact would be through the chequing account where salaries and wages are paid in and payments made out. That is the principal relationship and then there are other things as people move through time and life.

Q351 Mark Garnier: But it is vital for your business to operate that you are selling other stuff to these customers. You simply can’t exist without selling, can you?

Guy Whittaker: Time after time when we have asked the question-and I know it was debated internally as well-the majority of customers have said that they like the notion that they do not pay for some of these basic services. The corollary of that is that there are also risks and costs in providing for those, which need to be compensated for in some way. Therefore, you end up with a model, de facto, that has some cross-subsidisation built into it. Once you do that, you do have products with a higher profitability.

Q352 Mark Garnier: That is ultimately the key point, because of what I want to come to. I wanted to get a bit of background about what motivates your product-design department. Mr Geddes, you were managing director of marketing and strategy in retail banking from 2004 to 2006. What I want to get to the bottom of is what motivates an organisation such as RBS when you are trying to design product. How do you do your blue-sky thinking? Do you have guys wearing T-shirts sitting around on bean bags like at Apple or something like that? When you start these products, can you describe what goes on, and how you come up with one?

Paul Geddes: When you talk to customers, clearly the current account and the banking experience is at the heart of the relationship. Our strategy was to get people wanting to join us, and having a very good quality current account base, who think well of us, because, as you said, that gives us the opportunity to meet their further needs. As part of that strategy, we invested a lot of money in opening branches rather than closing them, we opened branches on Saturdays, "SatWest" came back-

Q353 Mark Garnier: You are catching your markets, so now you have got to sell them something.

Paul Geddes: What that access then gives you, at the counter or at other times, is the ability to look for things that that customer might need. For example, the end of the tax year is the ISA season, and that would be an obvious thing to talk to customers about; it may have looked like they needed further borrowing because they were reaching their overdraft limit; similarly, if they had huge balances in their current account, they may need savings accounts. Clearly this model, which is a global model, gives you the opportunity to talk to those customers. When you talk to those customers, clearly you need something attractive to talk to them about, and products are bought rather than sold to a certain extent, so we needed to have attractive rates and products with good features and products which the customer advisers in the branches felt confident to talk to the customers about.

Q354 Mark Garnier: You talk about the fact that products are bought rather than sold. We know for an absolute fact that current accounts are very sticky; people do not move their bank accounts very much. So you now have a big advantage: having won that market share with those 12 million accounts, you are now in a strong position to go out and sell because the hard part of winning the customer in the first place has been done by getting their accounts in. Now you have a captive market, to a certain extent.

Paul Geddes: I would not describe it as a captive market. We-

Q355 Mark Garnier: More captive than, say, when somebody replaces their car, though, you would agree?

Paul Geddes: It gives you access to have a conversation with a customer. We found, for example, that we had quite a low market share of mortgages, which was partly because our mortgage rates were not the most competitive in the marketplace.

Q356 Mark Garnier: But you would have set the mortgage rates along a price demand curve where it suited you best, because you do not want to lend endlessly at the wrong price. You would have got that right, presumably?

Paul Geddes: Indeed, but what I am saying is that people would not have given you their mortgage just because you were their bank. People give you their mortgage if you offer them good value and good terms.

Q357 Mark Garnier: But you would get the first call.

Paul Geddes: No, but you might be lucky that the customer is coming to talk to you about a change of address or something. It gives you an insight into the customer, and we have used that to identify good conversations to have with various people: with customer advisers on certain products; mortgage advisers and people to do savings. Part of the investment in the whole ship was so that you would get customers thinking well of you and you would get the chance to talk to those customers.

Q358 Mark Garnier: But you have got to sell them something, haven’t you? It comes back to that fundamental point, and what I am trying to get to is how you come up with a product to sell to them. If you are not selling them stuff, you are not paying for your branches and your ATM machines, so how do you design a product? What are you doing to get a product in front of the customer? You have got to come up with a product in the first place, so how do you come up with it?

Paul Geddes: And it has to be an attractive offer for the customer, so if you are saying, "Come and talk to my mortgage adviser: we have got some great mortgages in at the moment"-

Q359 Mark Garnier: But how do you come up with that? Do you see what I am getting at? Who sits in a room and comes up with PPI, and what is the driver behind that?

Paul Geddes: We have product teams that look at what the customers value in a product and what the competitors offer in the marketplace, and then we say, "Here is what NatWest can bring to this marketplace". We can bring high-quality products; we can bring features and benefits; we can develop an offset mortgage, because customers like to offset their lending and their borrowing; we can have a more fully-featured product here and we can have a guarantee to beat your mortgage offer here. In each of these marketplaces you face different competitors and you need to compete for that business because, again, just being someone’s bank does not, by nature, give you more than a right to talk to them. They do not necessarily need to buy from you.

Q360 Mark Garnier: You start off with your product team that comes up with a blue-sky idea, and then what happens? What is the process of turning that good idea into something that you can then take to market? How do you go through the actual product design and approval process?

Paul Geddes: It is a very extensive process. I think the nature of this market is that all these products are relatively mature, so these were probably evolving product features and changes. Probably the offset mortgage was one of the more disruptive products, but these come along only every few years. So it was more of an evolutionary approach, because most of the product needs were met, and there was an extensive approval process that went, I think, all the way up to the board, and the evidence was that this product would be good for customers and met an identified need. We talked about customers a lot. We did focus groups. We talked to the people who talk to customers and said, "If this came to market, what should we call it? Who would buy it?"

Q361 Mark Garnier: What about the legal side of it? Let’s stick with PPI. What would be the function of a compliance department in this?

Paul Geddes: What a good PPI sale looked like was set out three times, effectively, during this period: in 2005, when ICOB set it out; in 2008 when ICOBS set it out; and then, at the end of 2010, when the principles were set out by the FSA. The last one is the basis for the whole redress process. We clearly designed a product to be not only meeting that but beating it, as I said to you before. We removed exclusions. We set out to have a better product. We set out to have a Defaqto five star. That is an organisation that ranks products, and customers have a currency to say, "That’s a five star and you are a four star and a three star," so we designed to have a five-star product. The pricing of it was set by the PPI pricing in the market at the time.

Q362 Mark Garnier: The reason I keep coming back to the compliance department is because here we are talking about a monumental mis-selling scandal, and what I am trying to work out is whether at some point in the process of constructing this product in the first place you get your compliance department in to have a look at it. It is a pretty fundamental point. Who is checking that this product is compliant?

Guy Whittaker: In terms of building products, from my perspective the best product design really starts with the customer needs. You should start right back at the beginning-what does the customer need? The facts on PPI-the notion that some sort of insurance at the time you incur a significant personal liability, and that you can insure against loss of job, ill health or potentially death-seem like a fundamentally pretty good idea. The product is then designed. It would usually come through the business channel. It would then be looked at by the compliance department, by a regulatory department, by a risk management department and by finance and accounting, and we would be looking at how we recorded and booked it from a legal point of view and from a tax point of view, and then obviously from a marketing point of view, with customer perceptions and so on. Depending on the product there would be an escalation of approvals before it was launched into the public domain. We would often go with test runs, small pilots and that sort of thing.

Paul Geddes: The case with this particular product is that the FSA came out in 2005 saying, "Here is the standard you now need to hit," and clearly, ahead of that, we made sure we were ready and put in the training. We put in extra disclosures. In fact, between 2005 and 2008, there were additional requirements and we made sure we were up to date with that.

Q363 Mark Garnier: Does the compliance department sign off a product? Does it say, "This is compliant in our view"?

Gordon Pell: Yes. Can I just come in, because retail banking is all about checks and balances? We do have bright young men in T-shirts and we don’t let them anywhere near the customers, simply because that is the reality with any business. Regardless of whether we are making cars or banking products, we have energetic and imaginative people coming up with product ideas. We have a sales force that has its own view. It wants something very simple that, ideally, it can sell large volumes of. That is one requirement. We have a compliance department, which quite rightly has a very real role in saying, "Actually, this is just too complicated."

At the end of the day it has to come to someone like me who actually says, "On balance, there are nine ticks in these boxes here, but I still don’t think this is going to work." I think we have an excellent record of saying, "Yes, okay, I can see this; I can see it out there." I’ve even been told by analysts, "You are rather negligent, or unadventurous." We are not going to do it. We are not going to do home equity loans, for example-for no reason. So there are checks and balances all the way through the system.

Q364 Mark Garnier: What I am trying to get to is whether some of these checks and balances are the right ones. For example, if the compliance department says a product is compliant and something subsequently happens to make it think, "Goodness me, we got that slightly wrong; perhaps it isn’t compliant now that we look at it again in a different light," it is conflicted, because it has said it is compliant and now there is an incentive for it to-

Gordon Pell: No, I am going to disagree with you on that. In fact, I created the first role of visional chief risk officer back in 2002. Previously risk compliance had all been dealt with by relatively junior individuals within the businesses. I said, "No, I want a very senior individual who is just as senior as my senior sales person. I want him on my executive committee and I want him to realise that he owns the whole process and has a perfect right to challenge anyone." He does not have to look over his shoulder because often things change, as we have seen in our dealings with the FSA, but actually because our own views change, society changes and customer expectations change. As far as I am concerned, the day after they agree something they can come back and say, "No, we have changed our mind."

Q365 Mark Garnier: But you don’t have a regulatory specialist looking at it independently and saying, "I think that’s okay," and then compliance can come back.

Guy Whittaker: At the high-level controls framework, there would be three lines of defence-I am sure you have heard this in other forums. Typically the business would have its own risk and compliance department. There would be an independent risk management and compliance function looking at that, as the industry changes and regulations change, and reviewing those products and updating, where appropriate, policies and practices. You then rely on your internal audit function to sample these various things and then come back and confirm or negate whether an individual unit, person or service was compliant.

Q366 Mark Garnier: You talk about the three lines of defence. This is a failure of the first and second line of defence, isn’t it? The institutions who have been selling this have now been exposed to the great problems, so the first level of defence has failed. Indeed, you picked up, quite rightly, that there were 5,000 65-year-olds, or people over 65 who had retired, who had been sold these. I quite understand that your second line of defence, looking at the business end, picked that and went round and reversed that. None the less, it seems that for a long time the second line of defence was not picking up the overall problem with this. For an outside observer coming and having a look at this, although you had paid out 80% of the claims, typically these products had been known as paying out 15% of the premium income, so actually they are hugely profitable products and they have been mis-sold.

When you look at these numbers with the benefit of hindsight, or over your shoulder-however you want to refer to it-there seem to be quite a lot of breakdowns and problems from one end of the spectrum to the other, arguably going all the way back to the point where you start, which is where you have a free-in-credit banking model that ensures that you have to sell other products that are profitable to keep your business alive. When you look at this particular one with these very high rates of return-they are very high rates of return, notwithstanding the fact that you had to pay the fine-you can see that there are perverse incentives to make sure that the process of creating a product ultimately suggests that the motivating factor behind creating it in the first place is profitability to pay for all the support that goes with those free-in-credit bank accounts. That is the argument that you have got to come back and clarify.

Gordon Pell: That, at the end of the day, is where it all comes together on my desk, as I said, from the product designers and the sales force. This particular product, as we mentioned, in actual income terms was not particularly relevant to the retail businesses. It came under the heading of a valuable product that seemed to have customer benefit. It met all the respective smell tests, both internal and external. MPs’ postbags, for example, are an interesting one-they are a useful flow of information that is totally independent. There was very little in MPs’ postbags before 2007. There is a whole series of reasons that said that this was a business-as-usual issue, with the Financial Services Authority, as always, wanting to raise our standards and us responding. But going back, this was a relatively modest amount of our income.

I will give you an example: in 2005, when I came back to run the retail operations, it was quite clear to me that we were probably heading towards some form of economic recycling. I was very unhappy with some of the lending products that were out in the market generally and the pressure obviously was to follow them. Northern Rock-I will give you that as an example, as that is public knowledge. We were under intense pressure from some other major players, mostly on lending products. I took a view and said, "No, I am sorry, but we are not going to go down this route." All our marketing people would have said, "Absolutely." There was a proposal to come up with a quasi-125% mortgage, because that was what was out in the market and was being hailed in the press at the time. I went to our chief executive and said, "No, I think we should pull back from lending because we are getting into a market which is not our natural core franchise. It will eventually damage our core business and impact on our customer base. I have been through this in ’91 and ’93 and I don’t want to do it again."

I had absolutely no resistance at all from Guy or any of his colleagues in the group. That decision probably cost us half a billion pounds over three years. It was absolutely essential for the business. The business then carried on through the current recession, continuing to make substantial profits, which is one of the few things I feel any pride about in all of this. But PPI was never even discussed in this decision that lending at these sorts of rates to customers generally will get us into serious trouble, and more importantly we will end up in disputes with customers.

Q367 Mark Garnier: It is very indicative of a culture, and this is how it has been interpreted. There is a big mis-selling scandal, and we now have an entire Commission set up to look at standards in banking. We are talking about PPI because it is very illustrative of the culture that we are all very worried about. That is my point.

I will finish in a moment, but I have one more question going back to the design of the product. Clearly, at some point, someone must say, "This is it," and define the regulatory parameters through which it can be sold and who it can be sold to. How are those enforced? It seems to be a failing-this is demonstrated by the 65-year-olds who were sold this-and somehow that regulatory framework has been breached. What is the analysis of how that has happened?

Paul Geddes: At each of the publications of what the standard was, we genuinely believed we met it. In between the standards, the 2005 ICOB and the 2008 ICOBS, there were further requirements, so the FSA would say, "Please make sure that you print and give the customer a copy of the cancellation costs," so we would mechanically do that. Then, in 2008, the standard moved up, and in 2010-two years after we published the product-the standard moved up again to say that verbal disclosure of that point was required. So we were written to to say, "Please put ‘written’ in," but it didn’t then say, "We must put ‘verbal’ in." It was later established that we should have thought that.

It was against a moving base of expectations that we tried to keep up, in good faith, and it is belated to say, as we did, that even with a form that told the customer to make sure they were eligible and asking them whether they understood this and this, and even when the form letters that perpetuated this were signed, half the claims came through claims management companies, and half of those never had PPI. If they had a different recollection of what was suggested on the form-the verbal evidence-the evidence trumps anything we have on the sales front. All banks have been unable to keep up with the standard that was latterly applied by the end of 2010. That is not to say that there would not have been mis-sales, but I am saying absolutely that the FSA wrote to us and the compliance team. We had no interest, intention or motivation not to hit the standard required of what compliance there was. That is a subjective matter to some extent.

Gordon Pell: Can I make one final point on that issue? By 2007, as Paul’s supervisor effectively, we were not particularly interested in £100 million income stream in the overall scheme of things. We were just having too many meetings on this subject. You have to take a view that says, "We’re all doing our best; we’re all trying hard, but can’t we find a way to move on? If we can’t, this is effectively becoming a non-economic product because of the amount of time we are having to spend meeting these compliance requirements." I reached the conclusion that the only way I could demonstrate to the FSA that its standards were being met was basically to record every single sale. I sent our head of manufacturing away to look at putting recording machines in every single branch in the country as the only way, when it really came down to it, to prove that a verbal assurance had been given. Short of recording it, how could we do that? He came back saying that the staff do not like it and customers hate the idea, but we could probably do it administratively. By then, of course, the world had moved on to slightly bigger priorities.

I am just saying that we really were looking at every option to meet the FSA’s requirements. We personally thought we were in line with what was required, but going back to the issue, if there was any real case of mis-selling, we would deal with it immediately and, during most of this period, of the claims that went to the Financial Ombudsman Service, which realistically would have been that sort of complaint, most-80%-were found in our favour.

Q368 Chair: Paul, you mentioned the rules coming in in 2005. Surely the rules have always been a subset of treating customers fairly. What rules are you talking about here?

Paul Geddes: No, of course. I guess my point is that under that principle, whether in a verbal conversation or not, there was clearly a stack of features with this product and one conclusion might be that these products were too complicated. I think there is a lot to learn from this. I am explaining why we acted in good faith, rather than saying that there are not lots of lessons to learn from all this. It was a complex product. It was quite clearly set out. There was stuff that we had to print and give to the customer and stuff that we had to say. We went to those standards. Those things changed over time and, of course, it is very hard. The big cost of this was probably with the products sold even earlier, before the FSA started to regulate it, because a huge part of the cost is the cumulative interest-the 8%. So you have standards in 2010 that are ultimately applying back to products sold in the ‘90s.

Q369 Mr McFadden: I think some of you were at the back when the trade union representatives were in.

Gordon Pell: We heard some of those conversations.

Q370 Mr McFadden: I want to ask about the picture that they painted of staff who were under enormous pressure to sell products. If they did not sell products, they were called up on that quite quickly and put into performance management and remedial teaching classes to raise their game. As key figures in the retail side of the bank, what do you think about the picture that they painted? Would you have been involved in the design of those carrot-and-stick approaches?

Gordon Pell: I will do a high-level summary. If you want to go back to the early ‘90s, you will probably have to blame me for helping to bring this in originally-the idea of payment by results in banking-when I was at Lloyds bank. It was nice to hear a comment from one of the union representatives that the old Lloyds bank tradition actually worked really well, which I would agree with.

All commercial businesses have some form of payment by results methodology. That is a fact of life. If you choose to be a teacher or a nurse, that is fine and is totally different. However, if you come into a commercial organisation, there will inevitably be some form of payment by results. It is fair to say that all the way back into the early ‘90s in all our discussions with unions, despite the fact that we agreed quite easily on 99% of things because we are all in the business of having a motivated sales force- everything else being equal I would much prefer to hear that the union absolutely supported what we are doing. I am quite lazy. I would like to have the easy answer. The issue of payments by results has always been around, and there were some elements of that conversation that I have probably heard in versions over 20 years.

Q371 Mr McFadden: So you accept that this was contested ground.

Gordon Pell: Let me just touch on a couple of issues that I did pick up, interestingly enough; 40,000 people actually earn relatively small amounts of money-I am afraid that I did not know the witness names, but the gentleman on the left said that-that are probably important to them, but are not going to change their lives. They are certainly not amounts of money that they would want to get fired over. On the comment about impossible standards, you cannot have an incentive scheme that operates with impossible standards. The aim is to incentivise people, not to frighten them.

We actually had a system that said, "Okay. On 31 December, there is a target." On 2 January, that target may be very different. There may have been a major base rate change. There may have been a major industry change. There is absolutely no point in keeping an incentive scheme running that is then completely unachievable. We had a process whereby we would effectively reset the targets at several points in the year. If the wind was blowing behind everyone, we would reset the targets mildly upwards. If the wind was making it look as if we would not pay out, there is absolutely no point in having the scheme. We might as well all go home at that point. You want to keep people motivated. We would bring the targets down to a level at which they could still have a decent go.

I am just picking out a couple of specific points. I cannot comment on the industry, but I have 25 years’ experience of managing 40,000 people. At the end of the day, I would much prefer to pay out the entire amount in the bonus pool. It is a very small amount of money, and it is actually about keeping those people feeling that they are part of the team.

Paul Geddes: In my recollection, we always aimed to spend the £18 million or £19 million effectively. On Gordon’s point, moving it away from people so that they could not earn it was poor psychology as much as anything else.

It is worth talking about how we saw the roles in a branch. Are you happy for me to elaborate a bit? There are three critical roles. There were the people on the counter, and their role in the process was to use the tools that they had to offer great service to the customer, because we wanted our customers to think well of us. That was our strategy-it was underlying our commercial success-and we wanted to find unmet needs, so to spot somebody with very high balances or very high overdrafts and encourage them to meet one of our specialist advisers who would know how to meet their needs.

Then, there were the people who were the customer advisers. The process they went through was quite a structured conversation with the customer-understanding either a full customer service review or one of our particular products. Then, there was the branch manager. Clearly, in terms of the customer adviser population, you have to try and achieve a few things. You want them to be motivated, to be happy and to sell appropriately, so there are a number of checks and balances-such that people who seem to be doing too well were doing so for good reasons. There was a lot of MI available to say-and quite a big population of 2,000-"Who are the people with outlying results and why are they getting them?" Then, you would have a real look at the quality of the files. You would talk to their branch manager. You would look at the cancellation rates and all sorts of diagnostics. So, on the right-hand side of the performance, we were very keen to check that the results were got for the right reasons.

Q372 Mr McFadden: Let me pause you on that, because given the growth in sales of this product, are you telling me that if somebody was going great guns and selling lots of these, they were called on it quite frequently and why they were selling so many was examined? That does not really fit with most of what we have been hearing.

Paul Geddes: During my period, the product sales were falling of PPI, and we were comfortable with that, and that was part of our business planning-from the ’06, ’07, ’08 period. Secondly, absolutely, if someone is getting points by selling customers a product they do not need, that is bad for the customer and bad for the bank-for example, high cancellation rates. Every time we got an incident of complaint, we would log that against somebody, and ultimately, if they did something wrong to mis-sell, they would exit the scheme. If we had high cancellation rates, we would spot that by exception reporting, and again the person would exit the scheme.

We were very diligent-as much as we could be-and aware of the risks of an incentive system that is product-based, and there is a big conversation about how it is right for it to move on, but given the risks of it, I think the checks and balances were in place to make sure that it was not achieved in the wrong way. Then, I think there is a conversation about people who had lots of conversations with customers, and clearly, they were less good at the job-by which I mean, less empathetic with customers and less able to recall product features when asked better questions. They typically would not be happy in that job. What happened to some of those people over time was that they got moved back into other roles in the branch. There were many other roles in the branch, including ones that were all about servicing the customer.

Q373 Mr McFadden: You will have heard me say to one of the union guys that if you have a mortgage adviser who is selling your mortgages, it is-

Gordon Pell: That doesn’t mean he hasn’t got a good job at RBS. Can I just make one quick point? One thing I have suffered over 40 years, and I have learnt to my pain, is that by and large if a business, branch or seller significantly outperforms the average for very long, either he is brilliant-and I would include the chairman of a public company in that-or he has found a particular niche that may or may not be acceptable. Therefore, the top 10 sellers in every product effectively got their own private compliance visit before any bonuses were paid out. It was not because they were not doing a really great job, but there was just a danger that they had managed to find-there are two things. One is that they have really got it right, and I should be learning from it. The other is that there is something there, and today’s success story is tomorrow’s disaster waiting to happen. I have seen that so often in my career that I am afraid I am quite neurotic about it.

Q374 Mr McFadden: On this business of checking, RBS has said in its evidence to us that "each customer was provided with sufficient information about the product to make an informed decision whether to purchase it." That statement does not quite sit with what you were saying, Mr Whittaker, which was that if you continue to have free in-credit banking, you will have these things tied together and this kind of mis-selling will carry on. It seems to me that either you are accepting that there was a problem here-you say it was created by the free in-credit banking model, which I am sceptical about-or that there is not a problem here, because everybody had the full information. I find it difficult to believe that both those things can be true.

Guy Whittaker: I think it is slightly more nuanced than that. The free in-credit banking model and cross-subsidisation imply that you will need to sell products that have a higher profitability to compensate for those which do not. You know those products will be subject to scrutiny and that there will be a market price for them, because we operate in a market. To some extent, we do not set the price for those products. They are widely available and there is no particular intellectual property that a bank has that another bank cannot replicate. You have to put all these checks and balances in place to compensate for that heightened risk around profitable products. Certainly during my time there, colleagues here and other people in product design and risk management would have acted with the best of intentions to ensure that we were meeting those standards.

Q375 Mr McFadden: But if a product is effectively tied to another product, be it a mortgage or a credit card, you do not have a proper market. You have experience in Argos. I could go and buy a telly anywhere, but I could not buy one of these anywhere, because they were tied in.

Guy Whittaker: Somewhere around half the people who took out a personal loan also bought this sort of insurance. That means that about half the people did not. It was on a non-advised basis, it was optional and there were lots and lots of checks and balances around inertia selling. Where it was found, it was stamped out. There were lots of areas where you would try to control it, but it goes back to the basic principle that if you have to compensate for something by selling something else, a safer and fairer system does not rely on that cross-subsidisation and the attendant risks that may at some point manifest themselves, despite all the best efforts to the contrary.

Q376 Mr McFadden: If all this advice and these health warnings were being given to the purchasers, why have so many of them been successful in their claims that they were mis-sold this?

Paul Geddes: The win rate is high for customers against every bank, because the standards, as I explained earlier, are compared with standards were set latterly. For example, verbal disclosure needed to be at a standard. Also, in terms of the weighting of evidence, even where we have signed evidence from a customer, these template letters, which say, "Here are all the ten things that might be wrong," and often all 10 are submitted, trump any of that evidence, because if a customer asserts it, it is very hard for us to go back to find the seller-the person that dealt with the customer or the customer adviser-who can say, "That is not what we said." It is difficult when they deal with a lot of customers over a period of time.

Q377 Mr McFadden: Let’s not call a spade a garden implement. Are you really saying that the claims process is now so weighted against the banks that payments are being made where there has been no mis-selling at all?

Paul Geddes: What I am saying is that the pure maths of these numbers show that virtually all claims now go straight through, to the extent that half the claims coming through claims management companies never had a PPI product.

Q378 Mr McFadden: Those are not being paid out, though, are they?

Paul Geddes: No, but I am saying that the text and the evidential standards show that this is now pretty much straight through, because it is clear that if you have a template letter and insert some stuff, it is very hard to challenge. In addition, we are being asked to have certain disclosures made that we did not understand had to be made. All banks missed the point through this process from 2005 to 2010. That is not to say that mis-selling was not going on, but I am saying that the win rates are associated with a level of evidence and a standard that no bank has found it possible to meet.

Gordon Pell: I have been away for three years, so I read the newspapers and thought, "How has this gone from that messy inter-bank regulator discussion to these numbers, which are a tsunami?" I have been involved in real mis-selling issues over the years, of a relatively modest size, but one of the first things you have when you decide to sit down with a regulator is that you say you need a process that is fair to the customer and has an easy formula, and then you need one that is fair to the organisation. The word, normally, is proportionality. In other words, the remedy has to be considered to be proportional.

When I first came back, I said, "How has the number, which even in my worst fears I would have said was hundreds of millions, grown into numbers that are astronomical under any standard or precedent in 40 years in this industry?" I think I have reached two conclusions. One is that there is something called a mis-selling scandal, which is the terminology we are using here. I entirely agree that there has been an element of mis-selling, and, quite frankly, that could have all been dealt with relatively easily and at much less cost than what we are talking about here. And there is something called a refund of premium. It may be absolutely logical for a regulator to say, "This product should never have been sold to anyone, so please refund all premiums ever." That is a totally separate process.

Mathematically, this one seems to be merging with that one. The first question I asked when I got back after three years was, "When the proportionality discussion was taking place, what was the view of the banks and the regulator? Everything else being equal, where would this all end up in terms of paying?" I gather that the figure that came out of the banks was something like £8 billion, but the figure that came out of the regulator was £100 million. In terms of proportionality, someone has obviously got it dramatically wrong. Even the banks have got it dramatically wrong, in terms of setting the ground rules by which this exercise has taken place. Either we believe that every single product ever-that is the theoretical situation-has been "mis-sold", to use that terminology, over 20 years, and 40,000 people have got it wrong, plus every single bank executive of every organisation in the country, or the ground rules have got it wrong, and no one seems to want to get around to addressing that issue.

Q379 Mr McFadden: Let me close on this. I have to put it to you that the sums involved are huge-I accept that; across the banks-whether we are talking about £10 billion-

Gordon Pell: I think it is £13 billion in provisions. Speaking as a taxpayer, I am afraid that I would potentially extrapolate that.

Mr McFadden: If the banks had faced up to this sooner and addressed the problem sooner, these sums would be much smaller.

Gordon Pell: That was my opening comment, to be honest.

Q380 Mr McFadden: It was the banks that dragged this on for years, that increased ultimate customer dissatisfaction by doing so and that are now left with a bill.

Gordon Pell: I would leave this to Paul, because I really signed off in 2009, at which time there was a debate just beginning. I had looked whether we, as an organisation, could effectively break ranks, and Paul had had discussions with the FSA. You cannot break ranks in these situations, unfortunately, because the regulator would stop you, because it would say, "You might come up with a formula but, quite frankly, in three years’ time, some other organisation might come up with a different formula, and therefore your customers would have lost out." So you get a sort of vicious circle beginning to emerge in these situations.

Mr McFadden: So you are blaming the FSA for the banks-

Gordon Pell: No. I think you have a situation of human dynamics here. From the moment you get a big industry working party merging, it has to move very quickly to get to a conclusion. Paul, perhaps you would like to comment on why it didn’t seem to get there.

Paul Geddes: I think the relevant time here is that when the FOS changed its position, claims management companies got involved, and it became clear that we could not evidentially agree with the FSA what a sound sale was until we took it off sale. That was a year. In 2007 the issue flared up, and we took the product off sale at the end of 2008. We could have probably done it a few months earlier.

Q381 Mr McFadden: The super-complaint was in 2005.

Paul Geddes: But that was on a different basis. It was on the Competition Commission, and it was about how you should view the profitability of this product, and whether there was a competitive market in PPI, which was a different strand of work.

Q382 Chair: Sorry, could you repeat that about 2005?

Paul Geddes: The OFT referred the market to the Competition Commission, which took it up in 2006-07.

Q383 Chair: Yes, but huge questions have been asked in Parliament in 2005, not least by myself, directly to the chairman of the FSA and the chief executive, saying, "There is a scandal here. Will you look at that urgently?" There was a huge heightened interest in that at the time. I would have been surprised, given the microscopic interest that the banks and the Treasury Committee had at that time, that you would not have looked at that and said, "Look guys, what can we do ourselves here?" in 2005.

Paul Geddes: Absolutely. The trail of events that led to the referral by the OFT to the Competition Commission was running on a strand of work that was all about "Is there a free market in PPI? Is that why it is so profitable?" That concluded by saying that it was so convenient for a customer to buy it alongside their product that they banned the point-of-sale existence of the product. What ended up being the issue, in retrospect, was mis-selling. During these years we were having good, constructive conversations with the regulator, and we had very low postbags, as did you. It was a slightly different issue that was taking quite a lot of attention and time, rather than this one.

Before I left the business, one of the last things I did was to go to the FSA and propose a past business review, which involves writing to the customers that have had this product and saying, fairly, "Have you bought this on the right basis? Were you aware of these things? If you were, what would you have done differently? Have you bought the product in full knowledge and for the right reasons?" That exercise got caught up in an industry-wide exercise, because the FSA clearly wanted everybody’s exercises to ask the same questions. Then, I understand, the expectations of the standards to be met became evident, and that went into these elongated negotiation processes, which ended up with the JR, which ended up with this protracted period of time. Our interests, reputational and financial, would be for the speediest identification of this.

Q384 Mr McFadden: Let me ask you about policy advice. If car companies have a product and a fault develops in it, they recall it very quickly. They know that reputationally for them, a fault is a huge problem. They want their customers to come back, so they say, "Bring your car in. We will fix it and it will not cost you anything. We see that as reputationally very important." This process, from the time the concerns were being asked, before I was elected, in Parliament by John McFall and others, took years and years and years, and there was all that tortuous stuff that you have been outlining. Why, with financial products-I mean this as a genuine policy question-is the process of recall and correction so long lasting, difficult, expensive and frustrating for the customer compared with other areas where if you have a consumer product you either take it back to the shop and get your money back, or you get the product taken in and a repair done, and it is fixed? You probably think more of the company that does that afterwards, even though there has been a fault. They probably go up in your estimation if you go through that, compared with what we have been talking about today.

Gordon Pell: Let us deal with the customer who decides after he has bought a product that he does not want it or he is ineligible. I can absolutely guarantee that if he had come back to the shop-he has 30 days, anyway, to decide-and said, "Look, I am really very unhappy with this," I cannot believe there would not have been a sensible discussion and they would have been given the money back. We have to live with these people in our local communities. They are in and out of our branches every day, and they are doing other business with us. It is absolutely not in our interests not to give the money back when they ask consciously.

A car is easy, because it is fairly obvious that there is a problem, for example if there has been a major accident. There is clearly a point, and there is clear evidence of it, as to when things have gone wrong. The problem with this product is, as I explained at the beginning, we have spent with the FSA a lot of time building the foundations and it would have been relatively easy to say-perhaps I should have worked it out-that really no-one actually wanted this product on the street. That is fine; there is nothing wrong with that. There would have been huge implications: we would have withdrawn from lending to a huge chunk of the customer base and margins would have gone up significantly. There would have been costs in this, and it would have involved a massive rebasement of the industry, but it would not have been the end of the world.

I will just give you an example of how it worked the other way. Back in the early ’90s, I remember a conversation where Brian Pitman opened my door and said, "I have just come from the Bank of England. They are becoming very concerned about the amount of lending that is being used out of mortgages and is ending up in equity release for cars and holidays. Turn it down." That was the end of discussion-no need to produce evidence-and we got on with it. I am pleased to see from Martin Wheatley’s submission, I think from their point of view-

Q385 Chair: But Mr Pell, there is an issue here of personal corporate responsibility. I am thinking, "Why am I sitting here with this panel?" You remind me of "It’s a Wonderful Life" and James Stewart-everything you have done has been perfect. Why are we having this examination? I am puzzled. With an organisation such as yours, you are not equivalent to Tesco, who had horsemeat found in their products the other day, and in every newspaper today there is an apology. I put it to you that you knew that there were problems with the products and you knew that you had a regulator who-Martin Wheatley is on the record saying this-challenged you, but you pushed it back so that it would do further studies. You kept pushing it back until you got the judicial review in 2010, which Angela Knight said last week she was not in favour of. She said that she had the most uncomfortable five years of her professional life as chief executive of the BBA.

There are two levels here. There is a public relations level, where everything you have done is fine, and a private level where you say, "We’re going to push these people back because this is a profitable enterprise for us." The senior people at the FSA have said to me that they were too soft, and did not have the attitude or the resources that you had to push them back through the courts, and that is the reason we are here.

Paul Geddes: All I can say is that from finding out that there was a problem, which I am saying was at the start of 2008, of the scale that it was-

Q386 Chair: We are talking about 2005 here, Paul. It is matter of public record, which I will send to you. This was mentioned in Parliament in 2005.

Paul Geddes: It was mentioned in the context of the-

Chair: And I mentioned it to Fred Goodwin and others when I spoke to them.

Paul Geddes: All I am saying is that, in terms of the end procrastination, arguably we could have taken the product off a few months earlier from 2008, when it became clear that we could not reach an agreement with the FSA. In 2009, we proactively said that we wanted to go and remediate with customers. It is regrettable that it has taken so long. I would say positively that one of the lessons I have learned from this is that the relationship with the regulator is absolutely critical. I now sit on the practitioner panel and I have a huge amount of time for the initiatives that Martin has brought on. Early engagement at a very senior level to sort these things out immediately is absolutely imperative, because in the elapsed time, for reputation, it is expensive, it is bad for the customer and it is bad for trust. I think we can all agree that it is very regrettable that it has taken quite so long.

Q387 Mr Love: I remind you, Chair, that we had Citizens Advice in front of us, which took the super-complaint. It had originally started publicising this problem in 1999 and 2000. Indeed, there was increasing public concern about this long before 2005.

I want to ask what executives knew about the situation with PPI. According to the FSA, a very substantial proportion of the UK profits of major banks over a decade were derived from PPI. How aware were each of you? You seem to be hinting throughout this session that you were not really aware of this-how aware were you of how substantial the profitability of PPI was, Mr Pell?

Gordon Pell: In terms of the profitability of the product itself there is absolutely no question, for all the reasons we have discussed about cross-subsidisation. Even the Competition Commission has said that the fact that a product in its own right is very profitable is not actually evidence that it is unsuitable. However, in terms of it being a big contributor to the profits of the business, which is what you could argue resulted in dysfunctional behaviour, as I have said before, it was a relatively modest amount of the actual profits of the business. When, in 2005, we decided to reposition our lending position, PPI income was inevitably going to fall. That was never given even a moment’s consideration; the issue was where we positioned the business. Guy, do you want to comment from the group position? You were the holder of the overall purse-do you remember a situation where PPI income was ever discussed in terms of a constraint on the business?

Guy Whittaker: I don’t recall ever having a conversation with you about PPI. In fact, when I joined the group in February 2006, one of our earlier conversations was in the context of your repositioning of the business at that time, balancing away from a lending-driven model to a more balanced business approach.

Q388 Mr Love: Mr Whittaker, I am well aware, because the Treasury Committee has had the banks before it. They are very coy about this whole issue of free in-credit banking and how much income is generated from various parts of that free in-credit banking market. We are aware that they have figures privately-commercially sensitive, no doubt-and you must have been aware of where the substantial proportion of your profits was coming from and how important PPI was to that.

Guy Whittaker: Again, from a contextual point of view-I would prefer that we go back and get you the actual numbers that existed at the time-PPI represented something in the order of 1% of group income. If we estimated the profits of a loan-

Q389 Mr Love: You are talking about the whole of the RBS group. We are talking about UK retail banking.

Guy Whittaker: Again, I do not want to put numbers out to you that I cannot substantiate, but we estimated there may have been £300 million in retail banking, which, if I recall, was in the order of £1.5 billion to £2 billion at the time.

Paul Geddes: I can help you with some figures here. For example, in 2006, the interest on the loans was £440 million. The fees and PPI were £230 million. Total income: £670 million. Costs were £160 million. Bad debts were £500 million. Profit was £10 million.

Q390 Mr Love: So that was a substantial proportion of income.

Paul Geddes: No. Of income in 2006, that was 4.8% of the divisional income. As I said, the income of this was put alongside the income of the credit product: the costs of both, the bad debts of both, the profit of both.

Q391 Mr Love: Unless RBS was completely different from other major banks-as I understand it, you were a major player in the PPI market-how do the FSA figures reach a different conclusion?

Guy Whittaker: Retail banking was around £5 billion or so at that time. The premium income on PPI at the time was £248 million, so roughly the 5% number that I talked about earlier.

Gordon Pell: In 2005 I was asked to become the industry representative on the senior practitioner panel of the FSA. I continued there until my retirement in March 2010. The FSA had a direct line to my desk if they felt that there were any issues. We did not have to go through evidence or anything like that. I was used to a culture where we would have a mature conversation and move on. As their adviser on the panel, you would think their industry expert could put an arm round my shoulder if there was a major issue. I never remember that being raised. It is mathematically incorrect as far as we are concerned, although I accept that the way they may have expressed it is slightly different, if you see their wording. It was never a significant part of the profits of the business. It was an important part, but if it had gone for some reason-if the whole industry had moved and withdrawn it-lending rates would have gone up. We would have got probably half the income back, because lending rates would naturally have gone up, because there was an element of cross-subsidy.

If PPI had been instructed to remove it, lending rates would have gone up and a significant number of people would have found that they had no access to lending. Inevitably it is the less affluent. This is why we take such great care in who we sell it to. By definition the people who need it are the ones for whom we actually have to go the furthest to make sure that we are actually selling it to the right people. So PPI was a product overall that ended up with a situation in which lending went further down the market in terms of interests of social inclusion than probably it would have done. Interestingly, I heard a comment from the union about so many people now having to go to payday loans. That is because lending rates have gone up very significantly now that the PPI product does not exist any more. There is a natural ebb and flow in all this.

Q392 Mr Love: Yes, but you are characterising it slightly differently than I would, because the profit made on PPI was far greater than the subsidy to the loan that you are talking about to keep interest rates down.

Gordon Pell: I am sorry, that is mathematically incorrect. During the vast majority of this period, the overall personal lending product was, at best, marginal. In fact, in an absolutely rational world, you probably would not have lent to a large proportion of the population. You would have lent to certain segments, but you would not have had a broad offering on every high street in the country, everything else being equal, to everyone who walked in the door. We recognise that we have a responsibility to offer that sort of service regardless of the overall economics of the product. We are in a 30-year business. We lend to someone at 20. That may be an unprofitable product on that day. Perhaps when they are 50, they will do some business that is worth having.

Q393 Mr Love: Are you saying that the two things-PPI profit and the subsidy towards the loan-effectively cancelled each other out?

Paul Geddes: I have the numbers in front of me.

Q394 Mr Love: Perhaps you can supply them.

Paul Geddes: I am very happy to.

Q395 Mr Love: Mr Geddes, can I come to claims? You mentioned earlier that the number of claims that were refused because of mis-selling was quite high. As I understand it, the claims rate was less than 20% of premium income. That compares with car insurance where it is greater than 80%. Was not there a role for some competitive reduction in premium in order to make the product more competitive?

Paul Geddes: There are a couple of things to say on that. The 88% that I mentioned was the people who claimed and who we paid. The pricing of the product was that of a product with a low loss ratio and a high commission rate, which was effectively competed away in the lending market; that was the nature of it. The price was set referenced to what the market charged for PPI. Against that, we at least made sure that the product was fully featured and was the best product on the market. So we were charging in the PPI marketplace a competitive price versus our peers for a product that was better. Absolutely, the fact that these two markets are interlinked was the point that we were made to the Competition Commission. People are effectively buying a protected loan, so separating the economics is somewhat artificial in our sense.

Q396 Mr Love: You mentioned in an earlier answer to Pat McFadden that there was a competitive market in this product, yet in their evidence to us, RBS said, "We believe that the PPI products offered by the group were substantially similar in nature and scope to those offered by other banks and PPI providers." Why, when there was supposedly a competitive market, was there such uniformity?

Paul Geddes: There was a competitive market for protected loans. The mechanic was that the customer oriented themselves largely around what was the best rate for their risk and then their mind turned to, "What if I lose some income, and am I going to decide to protect it?" It was an integral sale, but most of the competition happened on the loan side of it, rather than on the PPI side, because that was the customer psychology. When they are in the market, it was who to go to-it was the interest rate or the loan that was most attractive. What I said was that it mattered to me, across all of our products, that we made sure that our positioning was helpful banking. We wanted the best products that we could get and therefore go into a five-star product. I think that there were important differences. We offered five years of protection if someone became disabled; the market offered 12. We did not exclude back pain. So I would say that we did have a better product. Was it dramatically different from the nature of the rest of the market? No, it was just better in some of the key features.

Q397 Mr Love: Earlier, you mentioned commission rates, which were extremely high-I think that you would admit that. Was that a reason why we did not have a competitive market? Everyone was protecting their commission rates when, clearly, they could have been reduced and still have produced a level of profit.

Paul Geddes: The Competition Commission judged that PPI was so profitable, viewed separately, because the point of sale advantage that you got from being a loan provider was significant. Therefore, the Competition Commission found that it was less than a competitive marketplace for PPI. Your diagnostic is in line with where the Competition Commission came out. We regarded the market as an aggregate market rather than two separate products. On that basis, it did not look super-normally profitable. In fact, when you see the figures I show you, you will scratch your head and say, "If you then take into account the bad debt experience that we suffered in 2009-10, marginal is actually the best description you can make of this." In our conception of the product, we did not see these as split-up things. In our conception, it was an entity which was our personal lending, and it was an offset to expenses incurred elsewhere.

Q398 Mr Love: So what you are really saying to us is that it was the packaging of both products together that was essentially anti-competitive.

Paul Geddes: The Competition Commission judged that there was no separate market in PPI, because it was so clearly easier for the customer to buy the products at exactly the same time as the-

Q399 Mr McFadden: Easier for you, too.

Paul Geddes: Well, the best place to sell PPI was in a branch at the same time as taking out the loan, because that is when the customer thinks of these issues.

Gordon Pell: Can I pick up that point? Obviously, I had similar discussions before. I said, "Okay, we keep on being told it is too easy for us in branch. Go and speak to the group’s insurance business and get them to launch a product which is not branch-related that people can buy on the internet or via the telephone, with totally different cost economics." They did go away-I am sure that RBS can provide you with the details-to see if we could come up internally with a totally different product. We launched it under the Churchill brand, and I believe that there is another company that had a similar product; I think maybe even the Post Office did.

Q400 Mr Love: But the reality is that you were in a one-shot game. If you did not sell PPI along with the loan, you would not sell it at all, so you had to do it that way. You had to package it together.

Paul Geddes: The customer viewed it in combination, and we viewed it in combination. Subsequently-CC said they could not be sold at exactly the same time-another, stand-alone product has been developed which does not have those characteristics. But that was how the market was viewed. The CC came to their judgment, and we did not JR the CC.

Q401 Mr Love: As I understand it, recent figures have shown that that stand-alone product is not addressing even the market need for these products. It simply is not selling in the way that PPI sold, so you had to package them together.

I do not want to go into that. What I am really trying to get to the bottom of is why competitive forces did not operate here. Was it the high commission rates? Was it the packaging? Was it the lack of information to the consumer? After all, quite a lot of evidence is emerging that many consumers did not even know they had purchased PPI at the time. Which of these is responsible for the lack of a competitive market, or is it all of them?

Paul Geddes: We don’t think it is the latter. Customers through 2006 had a cooling-off period. The consumer research and the FSA’s own research says that 70% of customers are aware of their rights and cancellation rights. It is clear that the best customers largely do not think about the product until they have the loan. At the time when asked what they will do if certain things happen to them, that is a convenient time to explain the product and that is when customers like to buy it. The point-of-sale advantage therefore meant that the bank was the best person to sell to that need.

The CC found that that was not acceptable and removed the point-of-sale advantage. Subsequently, when people have left thinking about the loan and how they will pay for it, it clearly emerges that later on, they are less likely to go buy a stand-alone product.

Gordon Pell: Can I touch on the word "packaging"? PPI was never conditional on buying a loan. You could be credit scored and you would have the loan whether you bought PPI or not. It had absolutely nothing to do with the credit scoring. There is no credit decision based on whether you bought PPI or not.

Q402 Mr McFadden: Do you think the customers understood that?

Paul Geddes: Yes.

Gordon Pell: Yes, absolutely. The form itself makes it very clear. If you would like to have a copy of the form that customers sign at the time, I am happy to let you see.

Q403 Mr Love: Would you accept that some of the emerging survey information indicates a lack of knowledge on the part of consumers, many of whom did not realise they were purchasing this, or only had a very scant view of what they had purchased. Indeed, that is one reason why claims were as low as they were.

Paul Geddes: In the period 2005 to 2008, which I can talk about, there was extensive work to clarify that customers did know what they had bought and that was an ongoing piece of work. In terms of making sure all the information was fully understood, we made changes, some bilaterally; the FSA worked with us to make changes. I think it was a consensual process of making sure that that was an improvement, but I think wholesale assertions-certainly from the time that I was looking at this product, customers were pretty clear that it was a separate product to the loan, that it was not conditional-

Gordon Pell: Can I just stop you? I can understand the cynicism, but even now you would argue in our most usurious and I would argue possibly in our most successful period, 50% of customers, even in our main sales channel, left the room without buying PPI? In some of our channels, 80% of people left the phone call or the room without buying PPI. I remember having a discussion with the FSA on one channel, where clearly they had found some sales defects. At the end of it, I said, "Right, if this is effectively an obligatory sale, how many customers leave the room…"-90% of customers did not buy the product. There were procedural issues-absolutely right-but I have never seen too much evidence of the fact that you could not leave the room without PPI in RBS. I emphasise that.

Plenty of other people sold far more PPI relative to their customer base than we did. We were always very careful. If I had seen the penetration level-that is, the percentage of customers who had bought our product compared with the ones who entered the room-rise much above 55%, 50%, I would have been talking to Paul and saying, "Actually, going back to my issue about success, why have we got a situation where it appears that more than you would logically expect-look at all the reasons; it is not appropriate for some customers-appear to be achieving it?" That same rule applies in branches.

Q404 Chair: Do you think that customers who bought single premium were aware that they were buying single premium products, in that the loan would continue for longer than when they paid off the premium? PPI is sold alongside the unsecured and secured loans, paid for up front by adding the premium to the loan, which meant that the consumer paid interest on the PPI premium as they paid it off over the course of the loan. Given that most personal loans were repaid early, the single premium structure was inherently unsuitable for most consumers. I have figures here. By the way, on the figures you have given us, we have no opportunity at the moment to contest that, but we will be looking at them in future.

Paul Geddes: The refund profile of this-known as the rule of 78s, which basically frontloads the costs; if you cancel, you do not get all the money back-fitted the nature of the claims, which is-

Q405 Chair: Let me give you an example, right? A PPI policy with a consumer borrowing £91,500 sold PPI that added £22,500 to the loan. The cost of the insurance was added to the loan and repaid over the full 25 years of the loan, but the cover provided by the insurance only lasted five years. Is that an appropriate product to be selling?

Paul Geddes: I can speak to the product that I was most focused on at this time, which is the-

Q406 Chair: Which would be in RBS as well?

Paul Geddes: Yes, but I guess what I am saying is that the profile of the claims and the risk on the single premium loan product is frontloaded, so more people claim early on, because they may have an instinct that one of the reasons you might claim is apparent. There is a symmetry therefore between the refund profile of the product and the claims experience. I would have to, outside this room, look at your mortgage example; I am not close enough to that I am afraid.

Q407 Mr Love: Arising from a previous answer about penetration rates, can you confirm to us that the penetration rates were round about 50%? What was the target penetration rate for PPI?

Gordon Pell: There would not have been a target. Sorry; are you talking about incentives?

Q408 Mr Love: Yes.

Gordon Pell: A branch would not have had a target penetration rate. A typical sales person would be given-in those days; I am not sure how it has changed in the past five years-a pot of likely sales points. They could then sell savings products or PPI. It depends on the branch. If you are in Brighton and the average customer base is 55, it is very unlikely that you are going to be selling a lot of PPI, so we would not give people a specific PPI target. You would expect them to sell savings products. I can imagine that there are some branches in areas of north London where you do a lot of personal lending and therefore a lot of their income would have come from PPI. That is absolutely logical. If for some bizarre reason we found someone in Brighton who was getting a lot of PPI income, I think I would probably want to know what was going on, because it did not appear to be the right sort of customer base. But I am not aware at any level-I do not remember Paul, for example, ever having a target for PPI income, either in penetration, volume or anything like that. It was never considered when we set his bonus and, in fact, overall retail income was never considered. We looked at it, as one of the issues, like customer franchise, the growth in customer numbers or the levels of complaints-issues like the FOS. Those were all issues that had to be addressed at all levels of the executive team. PPI income, going back to my other point, is a relatively modest part of the overall business. I was more concerned, quite frankly, with keeping complaint levels down on it than whether the income moved by £10 million or the other.

Q409 Chair: I have your Q4 2006 sales schedule-the points schedule for the detailed bonuses in 2006-and it shows what points were awarded to sales people for the sales that they made. Given that answer to the question, would you be surprised to know that, for a personal loan with PPI, the points are double that awarded for a personal loan sold without PPI?

Paul Geddes: No, and the relative points of PPI we reduced in 2006.

Q410 Chair: Okay. To what extent would you agree that this kind of scheme is bound to encourage mis-selling of PPI?

Paul Geddes: I absolutely agree that, having points based upon profit, there is risk in that approach. One of my reflections is that, therefore, it is absolute progress that has been made since, and I agree-

Q411 Chair: Hold on. Would you be surprised to know then that the points for loans increase as the loan size increases. I have the table here before me-for example, for a loan of £1,000 to £3,000, without personal loan protector 20 points, and with personal loan protector 40 points; or for a loan of £20,000 plus, without personal loan protector 315 points, with personal loan protector 630 points. To what extent would you agree that this encourages sales people to persuade customers to borrow more than they originally came in for?

Paul Geddes: I think there are clear risks in this sort of scheme-

Chair: But this is yours!

Paul Geddes: I know, I agree, that is what I am saying. Listen, in hindsight, I completely agree that incentives were an area that needed work. Clearly, there are risks associated with these sorts of schemes. We had checks and balances in place, to make sure that, for example, if we suddenly found someone selling lots of these things or the quality of the sales was low, his bonus would be taken off the table. Is it right to say that a £20,000 loan and a £2,000 loan are probably more involved? They take more time, but I agree with you that it is a risk. I think that a measure of a good incentive scheme is that it would be one you happily share with your customers.

Q412 Chair: Okay. Given that the single premium PPI is added to the loan, selling that increases the loan, so the salesperson gets points for an increased sized loan, and these are then doubled for the PPI sale. How far do you agree that that encourages double mis-selling?

Paul Geddes: I am unaware, but I will go back and check, but I think that the loan amount is the loan amount and the PPI is the PPI amount. Let me go and clarify that point.

Q413 Chair: Mr Pell, you just signed off these schemes.

Gordon Pell: Not at the level we are talking about now. There was an independent check and balance.

Q414 Chair: If you had not signed off these schemes, Paul Geddes has just told us that that is a real risk. I would see it as a risk with people who, as the unions said, come in with modest incomes, so they want to increase the take at the end of the day. If there was that risk, it surprises me that you were not made aware of that-selling that off-because this could have been all over the country, and the risk to your staff but also to your customers could be increasing very considerably.

Gordon Pell: May I agree with you? I would not have signed off the level of detail that we have just been discussing here. The reality of life is that, at all levels of the branch network, 50% to 75% of incentives are based on service; they are not based on this.

Q415 Chair: Let me try to be precise. You would not have been aware that there would have been double points for PPI sale.

Gordon Pell: Not specifically at that level, but people would have been, because Paul cannot just set an incentive scheme. He would have had to go to a group committee, chaired by HR people, outside the division, who have no interest at all in profit. That incentive scheme would have to have been agreed at the sort of level of detail that you are talking about before he was allowed to-

Q416 Chair: You have to take some culpability here, some responsibility-

Gordon Pell: Oh, totally. I take total culpability. In fact, I am heartbroken that we are actually in this position in the first place.

Q417 Mr Love: Mr Pell, earlier on in an answer, you were relaxed about penetration rates. You said that many people on the phones did not take up the opportunity and that 50% was a reasonable figure, but written into your incentive schemes was a decision that placed a priority on selling PPI along with a loan. How do you explain that contradiction? I know you take responsibility for it, but how do you explain that happening in your organisation?

Gordon Pell: Going back to my original point, yes, I agree with you that weighting has to be based, to some extent, on the profitability of a product. That is clear. But at the end of the day, the adviser can’t manufacture a PPI product. In other words, he has to have people coming and looking for loans in the first place, so in many branches he wouldn’t have the opportunity anyway because people don’t come in and ask for loans. If he has a customer base that is not appropriate-in other words, it is a middle-income customer base in an area with stable employment-he doesn’t really have that opportunity. It is clearly a risk.

Again, there are a lot of checks and balances that have to come in there. The sales force is incentivised to sell. I make no bones about that-that is what we run-but the compliance operation, the testing operation and the stiff test at all levels are designed to balance, and the purpose of that is to protect the customer franchise. We are not in the business of generating short-term income; it is absolutely of no interest to us.

Q418 Mr Love: You say that, but that is exactly what you did. While I take your point about the compliance function-that it should operate in the way you said-it didn’t, because we have massive mis-selling. And the reason for that-well, one of the reasons for that-was the incentive schemes that clearly highlighted to staff at the local branch that this was a priority, that they would do well out of it and the importance of selling it to the customer with a loan.

Gordon Pell: It is interesting, because I have obviously had the opportunity of sitting and listening to representatives of the staff bodies, and the comment was actually made-at the end of the day, we are talking about relatively modest amounts of money here, spread across a very large number of people, with 50% of the incentive actually based on service anyway. And if you had a situation where you have sales people who are clearly mis-selling or abusing the customer base, that reflects on the service scores that actually come back into the branch.

There are checks and balances throughout the system. Interestingly, he said-I cannot remember his words, but he actually said something like this: "We had no real evidence that actually any of our staff were particularly driven by incentives to actually mis-sell." My experience with branch staff-remember, I started as a cashier myself-is that issues such as self-esteem, wanting to be part of a team, not wanting to be personally unsuccessful, wanting to support your colleagues and how you are managed were far more important, quite frankly, to most of our 40,000 people out there than £1,000. There is obviously going to be the odd one. We have checks and balances to identify that person, all the way up to Paul Geddes. And where we found situations, we dealt with them.

Mr Love: All I can say is that all the emerging evidence from 1999, such as the Citizens Advice research, shows both the level of pressure that staff were under and the level of pressure that customers were under to buy these products.

Chair: We will check the record, Mr Pell, from previous ones, but the impression I got was that staff themselves did not deliberately mis-sell, but that the pressure they were under was considerable, and that was what they told us. Indeed, ever since I have been involved in this situation-since the early 2000s-I have had staff coming to me and telling me the pressure they were under. I have had people-not particularly from your own organisation, but from banking-coming and telling me that they have moved on because of the pressure, and because of their monthly sales target: "I need to sell the same to Mrs Murphy, aged 75, as they sold to John Cain, at age 25, and it was inappropriate." So these issues have been around for a long time, Mr Pell. I don’t think that we should kid ourselves on this.

Q419 Adam Tolley: In the bank’s submission to the Commission, there is an expression of regret about the tendency to promote products that delivered short-term income rather than long-term sustainable returns. Do you consider that PPI was one of those products that generated short-term income over long-term sustainable returns?

Paul Geddes: None of the three of us work for RBS now or were involved in this submission, but the generic point about the risk of incentives is well made. It is good that the industry is moving away from having incentives that are linked to the profitability of the product. In my new business, having incentives that you would be pleased to explain to your customers is a very good principle. There are cultural and incentives points that are important to learn from this period of history. We had checks and balances to ensure that bad things did not happen, but, underlying that, having an incentive scheme that your customers would be happy to see is an important factor.

Q420 Adam Tolley: I understand your point that you did not draft the submission, but what do you think the bank might have had in mind when referring to products that delivered short-term income, rather than more sustainable benefits?

Guy Whittaker: I will be happy to share my experience from the time that I was there. In a business with cross-subsidisation, high-profit products will always be sold to compensate for the things that are being provided either for free or below their cost of production. During the time that I was with RBS and on the management committee, as it relates to the retail banking business in the UK, much more time was spent looking at indicators on customer satisfaction, market penetration, waiting time in branches and the numbers of customers choosing to switch their current account from another provider to RBS than on short-term financial measures around that particular activity. From my perspective during my time with the company, I do not recognise that reference.

Q421 Adam Tolley: You think perhaps that someone has written that without having any particular product in mind at all.

Guy Whittaker: I think that you must go back to the author.

Paul Geddes: To try to be helpful, the generic comment, which I have acknowledged, is that having sales points driven by the three-year profit, which was the mechanics of the product, inherently creates some risks. While we hope to mitigate them, you clearly could not always fully mitigate. It is entirely appropriate to say that having different sorts of measures and different sorts of incentives has to be a helpful thing. If we did not learn anything from this incident, we would be very remiss. There is clearly a huge series of things to learn in terms of everything from product and incentive design to culture. I hope that our evidence so far is not to be confused by saying that we believe we acted in good faith, given the evidence that we were seeing. Reflecting on that, we of course have to take big lessons. Since I left, the bank has moved along the right path. The FSA’s new approach is to be applauded. As I said, in my current business, I would be very comfortable for customers to see how we choose to reward people.

Q422 Adam Tolley: I will come back to the question of sales incentives, but I want to return to the question of PPI policies and claims experiences. Just so that we are clear on the terminology, because there has been some confusion hitherto, I am talking about the percentage of premium received by the bank, but then paid out by way of response to claims. There is a different terminology for that, but we are talking about that particular measure. The general market experience in relation to PPI policies, as reported and collated by the Competition Commission, was that claims ratios were much lower in the context of PPI than in other traditional lines of insurance, such as motor or home contents. Presumably, the Royal Bank’s experience of claims ratios was similar to the general market experience.

Paul Geddes: Indeed. We were pleased with the percentage that we paid versus what was claimed, but this is a low loss ratio product versus other general insurance products with a much higher loss ratio. The reasons were explained to the CC, and the CC took a view that we viewed this as an associated product, economically and in the purchase, with the loan product. Therefore, there was the low loss ratio, but the overall economics were no more than acceptable.

Gordon Pell: This has to be looked at across the business cycle. There are certain points in the business cycle where bad debts and claims resulting from redundancy, for example, are actually quite low. There are points where that changes. If redundancy, for example, goes up significantly, obviously the claims rates change dramatically. We have not really had, in the period we have been discussing here, the sort of downturn that there was in 1991-93. You would have to get that sort of business cycle with a significant increase in redundancy to be able to make the comment that the claims ratio is sustainable across a cycle.

There are arguments that in early 2000 we were heading towards a downturn, but for very valid reasons interest rates reduced significantly. We have not seen the levels of unemployment, thank God, that I saw in 1991-93. If we had had that, I can absolutely guarantee that PPI claims rates would be through the ceiling, and we would probably be having a slightly different discussion.

Q423 Adam Tolley: The Competition Commission’s analysis was that claims rates-or loss ratios, as you might want to call them-varied from 12% at the lower end to 28% at the higher end. Compared with motor claims, where the claims ratio was more like 80%, that was, over a period of time, a marked difference. Taking into account your point about looking over a long period of time, none the less there was that stark distinction between claims ratios.

To what extent was that feature of PPI policies well understood at senior levels within the bank as a necessary part of the policy in the first place? In other words, in terms of the product design and the use of PPI policies in the business, to what extent was the low claims ratio understood as a necessary part of that?

Gordon Pell: We have had the discussion that PPI has effectively always been accepted-at a strategic level anyway-as a cross-subsidisation of lending rates. I don’t think that has ever been a secret. It certainly wasn’t a secret when you went to the Competition Commission. That is not an issue in terms of the individual customer who comes through the door, because it is not conditional in any way. At a strategic level, it is absolutely accepted that PPI was individually a very profitable product, and it was matched by a loan that, because of competitive forces in the market, was a lower level than rationality would have suggested.

I am trying to drag my mind back to history. I think loan repayment insurance was introduced by new entrants who wanted to come in with a very low headline rate on lending and then created a product effectively to subsidise their response. That was a very valid new-entry strategy. The major banks had to respond over time and it got absorbed in the system.

Q424 Adam Tolley: To be fair, we are probably in agreement. What you are saying is that the low claims ratio as part of the PPI policy was an inherent part of the overall aggregate that you have been describing-between the credit on the one hand and the PPI on the other. In other words, one fed into the other. The low claims ratio, and therefore higher profitability on PPI, fed directly into the lower APR rate on the credit itself. Is that fair?

Paul Geddes: Yes. That is the basis of our submission to the Competition Commission.

Q425 Adam Tolley: Is that feature and that link something that would have been apparent in relation to PPI policies from the outset of their mass sale in the market, or was it something that only occurred to you as time went on?

Gordon Pell: It is difficult to define what outset means. The product in one form or another has been around for 20 years. The debate about PPI really only goes back to about 2005. By 2005, the dynamics of what we are talking about-a loan product, which on any working standard would probably be described as leading-edge, in terms of the value to the British consumer, and the relative high profitability of PPI-were overt to everyone from the top to the bottom of the bank and, frankly, all observers of the industry. There was no secret; all analysts understood it.

Q426 Adam Tolley: Just to help you with a snapshot of the time, Mr Pell, this would be primarily for you to deal with. The RBS sales figures that have been provided show that in 2001, by comparison with 2000, there was an approximately 120% increase in sales of PPI.

Gordon Pell: Yes, I think probably because in 2001 RBS was a combined business with National Westminster. For reasons of history, National Westminster, if I remember rightly-and I really am having to plough my memory, as you will appreciate-did not really have a PPI product of any size, so you had the arrival of more active management, which was what the whole NatWest deal was about, and a business that had a very low penetration, which was, no doubt, for strategic reasons. I can see why you would get that percentage increase. It was not because people were suddenly selling far more of it, but you had a bigger business, of which two thirds of the business actually sold very few in the past and it had not really been part of its product range.

Q427 Adam Tolley: Was it the case that, in 2001, there were simply more people selling it in the group by comparison with 2000?

Gordon Pell: RBS was a significantly bigger business in 2001. In fact, the retail business was two thirds larger than it was the year before.

Q428 Adam Tolley: Coming back to the question of the design of PPI policies, given that it was apparent from an early stage that a necessary part of the policy’s construction was that it should have a low claims ratio, how did that affect the policy’s design in terms of its terms and conditions?

Paul Geddes: Let me put it this way: in the marketplace, there were low loan rates and there was a certain product price for PPI. We were competitively benchmarked versus both. The industry is characterised by an element of cross-subsidy in this area which, obviously, the Competition Commission found issues with.

Is that to say that people buying PPI did not buy it knowingly? How it can be a high-profitability product that is bought knowingly is, I guess, where we are going. The research we had was that the people who were buying it were the sorts of people who saw the value in it: it was professional sellers rather than civil servants who bought it. They knew what they had bought, they got peace of mind from it and they decided, rationally, that this was a sensible additional price to pay for the uncertainty that it removed.

As I say, on these various tests, was there supernormal profitability? Well, no, because that was not how we conceived of the economic measures of this. Customers knew what they had bought, and the right sort of customers were buying it and the wrong sort of customers were not buying it. That is why I am saying that it passed a common-sense test that this was a reputable product.

Q429 Adam Tolley: What were the features of the design of the PPI policies themselves that led to such low claims ratios?

Paul Geddes: I do not think that it was necessarily the features, but probably the price of them. As I said, it is not that this was a product that pretended to offer protection that was not then delivered-we paid out on 88% of submitted claims. And it was designed not to have exclusions; I took exclusions out. For the given claims cost, the market price of it was high.

Q430 Adam Tolley: You may not agree with the way I put it, but I think you are suggesting that PPI was overpriced by comparison with the price of the loan to the customer, so the claims ratio in relation to PPI looks much lower because the premium received was so much higher than you might otherwise expect. Is that fair?

Paul Geddes: I think so. The product did not present itself to be something it was not. It is not that by which you had our claims ratio. The market price of these products was relatively high in a standalone snapshot of it, but not when viewed in the aggregate of the total lending profitability.

Q431 Adam Tolley: On a related but slightly different topic, if a PPI policy paid out, as a matter of generality the idea was that it would enable the customer to avoid defaulting on her or his loan repayments to the bank with which they had taken out the policy. Is that a fair inference?

Paul Geddes: It means that the liability is either delayed or removed, avoiding them having bad credit repercussions and so on.

Q432 Adam Tolley: Would there not be some occasions when the customer would go on paying the lender but the insurer, who might be in the same group as the lender, would pay out a sum to the customer on the PPI policy?

Paul Geddes: I am terribly sorry. Can you-

Adam Tolley: Imagine a situation where there is a customer, a lender and a different insurer on the PPI policy. Sometimes the insurer and the lender are in the same group, but different companies. There is a situation in which the customer has a legitimate claim on the PPI policy, and the insurer pays out a sum of money in response to that claim, whatever it might be, based on the amount insured. The customer might, all other things being equal-let us assume it is a case of unemployment-use the money that they receive from the insurer to go on repaying the loan, which would mean that the insured sum is covering the loan repayments. The point I am trying to get at is that in this way, PPI insurance could provide a form of indirect credit insurance for the lender in that scenario. In other words, the money flows back to the lender, ultimately.

Paul Geddes: I think that is correct, but I think it was also captured in the economic view we had of the product. For customers of certain credit quality, we asked what the credit part of it would be and what the PPI bit of it would be, and given the profitability, the loan was priced at that level. I think that was captured in the effect that we have talked about, namely that the aggregate price of the credit was priced fairly given all these moving parts that you are talking about.

Q433 Adam Tolley: So you were taking into account typical experience of bad debts in pricing the PPI policy.

Paul Geddes: Yes. We said, "For a cohort of certain credit band risk, here are the credit implications and the PPI implications," and, therefore, the pricing for all customers of that credit quality, irrespective of whether they took it out or not, would be set at x APR to make a decent return. The effect that you talk about is captured in our view of this being, in aggregate, one thing and priced rationally.

Q434 Adam Tolley: This is my last question, or perhaps series of questions, on this subject. RBS has explained that all its sales of PPI were made on a non-advised basis. In other words, one was not purporting to give advice to the customer as to whether the product was suitable for her or him; it was simply a case of providing information to the customer to enable them to make up their own mind. Given those circumstances, how could the bank, at any point in time, be confident that the PPI policies that it was selling to its customers were suitable for them?

Paul Geddes: Suitability is on a couple of levels. One is, "Is this a policy you can claim on?" and I think we have dealt with that point to a certain extent. On a generic level, is there a need that a lot of people have? We know that only 30% of people have savings at all, and that number would be a lot lower among people who took out personal loans. Is it a need that a lot of people have? The answer is yes. Then it is for the customer to judge whether that need and the cost are balanced, and that is a free choice for the customer. I am not sure whether that helps.

It would be a product not suitable for you if you had lots of other sources of income. The sales process was designed around saying, "What would happen in this event? Tell me about your family background, your work situation and your savings." Through that line of questioning, the customer would come to their own conclusion that they would not be able to cope with their mortgage or their loan if something happened. That is why it is a non-advised sale, because the customer would come to a view, having thought about those things. The sales process prompted customers to think about those things, and I think they are good things to think about when you take out credit. The customer would judge against, "I have got a need," and they would look at the price and come to a view.

Q435 Adam Tolley: Presumably, the bank must have formed a view that it was reliable to sell these policies on a non-advised basis.

Paul Geddes: Yes.

Q436 Adam Tolley: In the light of that, was the bank confident that the typical customer could properly understand that they were not being offered any kind of recommendation as to the suitability of this product for their personal circumstances, but simply being invited to make up their own mind?

Paul Geddes: That was the process, that was the dialogue, that was the training and that was the paperwork. Of course, in all these things-not to be naive-there is always a risk that in that conversation, the member of staff overreaches themselves and says, "You should have this." That was not the training and that was not the nature of it. The nature of the structured interview, which was trained, was, "What would happen? What would happen? What would happen?" and it was then laid out. Customers who bought a lot of PPI were the customers for whom the answers to those questions were that it was quite likely and they could not do anything about it, and customers who bought much less of it were customers for whom it was much less likely and they could cope with it more.

Q437 Adam Tolley: With the benefit of hindsight, would you consider it was in fact reliable to sell PPI policies without giving advice as to suitability?

Paul Geddes: For the reasons I have stated, eligibility is different from suitability. Thinking things through is a relatively generic need, and PPI was purely optional for the customer-a lot chose not to buy. That is how I see things. For me, PPI feels like a product that is capable of being sold properly on an unadvised basis.

Q438 Adam Tolley: I appreciate this is going back in time, but prior to the FSA taking on responsibility for the sale of insurance and PPI, among many other examples, at the beginning of 2005, would you accept that sales of PPI were effectively unregulated?

Paul Geddes: When I arrived we were very much gearing up for ICOB, and training and everything were being put in place.

Gordon Pell: You really are asking me to go back into memory. They were not regulated in the sense that we have today, when the sales process is regulated; there was actually product regulation through various bodies. There is absolutely no doubt that 2005 represented a break point when the energy levels focused much more on the sales process than I ever saw earlier in my career, but I honestly cannot drag my mind back to what is now 14 years ago.

Q439 Adam Tolley: I understand. I am just trying to help you. The position prior to 2005 was that such "regulation" as there was was provided by the General Insurance Standards Council.

Gordon Pell: I appreciate that, but I don’t think it means that they were unregulated. They were clearly not regulated in the way we do this today, but at that time they were regarded as a regulated product.

Q440 Adam Tolley: The question is whether, in the period prior to 2005, the bank imposed for itself any standards on the sales of PPI policies, or whether the absence of regulation meant that the bank felt the thing to do was not-

Gordon Pell: No, most of the issues that Paul has defined, such as wanting to sell to the right customers and standards in the sales force, have been there during my entire career. I go back to the basic point that we live with these people-they are in the branch three times a week-and we have other business with them. We are not in the business of just selling products off the shelf, which has never been part of our proposition. There is absolutely no doubt that, after 2005, there was far more formality about what levels of documentation you might require. The problem is that from 2005 onwards, it has been a little bit like show jumping: if you jump 6 ft, you suddenly find that you are asked to jump 8 ft, which is perfectly acceptable, and you are then suddenly asked to jump 9 ft. There are ever-increasing standards, which goes back to my point that at some point I felt that the only way to prove you could jump 12 ft was by recording the calls, at which point you have to say that you have a situation where it is uneconomic to continue providing the product because of the levels of diligence that you are having to provide.

Q441 Adam Tolley: I will come back to the question of the cessation of the sale of these products, but on the switch to the regulated world of 2005, the group’s own figures show that, in 2005, compared with 2004, there was a 30% reduction in the volume of PPI sales. Mr Geddes said that the decline in PPI sales from 2005 onwards was part of your planning, that you understood that that would happen and that you were comfortable with it.

Gordon Pell: There was a seminal point in 2005-I can give you the slides from the investor presentation-where we stood up, and I remember the words: "We are effectively withdrawing from large areas of the lending market." We closed the Lombard brand, which was effectively selling off the phone, because I felt it was going into areas of the market that, with economic rebalancing coming, made that inevitable. We closed the Direct Line financial services brand, which was part of our business at the time. We withdrew from the First Active mortgage brand. Looking back, I felt that we clearly had a situation coming where we would have difficulty with customers in terms of lending if we were not careful. I had been through 1991-93, and I did not wish to repeat it. There was inevitably going to be a fall in PPI income. The idea that I was somehow being pushed to sell almost proves that it was totally the other way round. I would expect to see PPI fall. They are not quite connected, but lending volumes fell significantly. More importantly, the channels which marketed to customers who probably were more likely to buy PPI-I don’t know whether you remember but at one point Lombard was on the television every five minutes advertising loans. If you watch daytime television that is a reality. At one point we had a situation where Lombard and Direct Line financial services were almost back-to-back television advertising. When you pull those two brands you significantly change the shape of your lending book and you accept that you are going to sell fewer PPI policies.

Q442 Adam Tolley: Would you say that the fall in the sales of PPI policies from 2004 to 2005 was as the result of wider strategic changes that the bank was implementing?

Gordon Pell: There is no question. The fall in lending and the fall in income that took place in 2005 was the result of a discussion I had with the main board that I felt that the market conditions were effectively taking us into areas that I did not feel it was safe for RBS to go. There were implications of that-I don’t even remember PPI income ever coming up, quite frankly. We were looking at the overall shape of the business and our ability to maintain our overall income streams. PPI was a relatively small part of it. At the same time, we would have been going through a learning process with the new regulatory regime as well. Whenever you get this sort of discontinuity it takes time for the sales force to get up to speed, to relearn the rules and for us to feel comfortable with them. So I think there are probably two things going on here.

Q443 Adam Tolley: To what extent, if at all, would you accept that the introduction of the FSA regulation had an effect on the volume of sales of PPI at that time?

Gordon Pell: Any significant discontinuity inevitably results in a period of rebalancing. You have to retrain. People have to get comfortable with it. You then have to get comfortable with what they are doing. These situations inevitably involve a change in the pace of life. It normally tends to be slower rather than faster. That is what you would expect, wouldn’t you? Very different rules came in. We adapted to them. I would expect our sales volume to go down from a regulatory point of view. I would be a bit surprised if they went up, to be honest, because it takes our sales force time to readjust. I also make the point that we significantly withdrew from significant areas of the market that I considered non-customer friendly.

Q444 Adam Tolley: Just a few further questions, following on from the ones that you have already been asked about sales incentives. You have already explained something about the extent of incentives for sales staff in relation to sales of PPI and in terms of volume and quantity. What about incentives for both local and regional management on the one hand and for much more senior executive management on the other? To what extent were sales incentives for those sorts of individuals geared around the volume and level of sales of PPI?

Paul Geddes: Again, apologies for A, the mists of time and B, I have had limited time to prepare for that. As you go away from the branch it is clearly a more subjective, more holistic measure of a lot of things. It is not prescriptive by which particular products branches have in aggregate levels of points to hit. As we said, we moved those to be hittable, such that we wanted to spend the same amount of pot. If it was really hard we would make it easier. Then, as Gordon said, you would be intelligent about saying to a branch that it was selling more than we would expect or less than we would expect. We would put in either action about over-selling or corrective sales action saying, "Here are some coaches to help you sell appropriately to normalise it and get the sort of mix that you would expect." But I think as you went out from the branch and up the chain, this wasn’t a point system. It was much more general management sort of incentives which would have mixed up all sorts of achievement of strategic objectives, customer service etcetera. We can probably help you, if it would be helpful, just to go back and work out above the branch manager what then happened.

Q445 Adam Tolley: Yes. I appreciate that it is a very general question, but you may have heard some of what the unions said earlier. You have no doubt seen what they said in writing. I paraphrase, but they talk about cascading, if you like, incentives or targets down. In other words, to take a simple example, if the branch manager has a target that a particular number of policies have to be sold then that may translate into what might be described as a negative incentive for the local staff. In other words, they come under pressure-perhaps performance management type pressure-to sell so that the more senior manager in this particular situation can hit his or her target. To what extent would that be a fair reflection of your experience?

Paul Geddes: From my experience-in my new role-of visiting a lot of branches, there was a sense of how many of these points were accruing. The source of the points, between the various products, was intelligently set and not mandated. Obviously, there has been observation of a branch. You have a customer mix and you are selling very few of them. You ask, "Do you fully understand the products? Have you been through the training?" Similarly, you are selling too many of them, so what are you doing about it? Targeting on points and in aggregate was the main mechanic, and points obviously required sales. I think we had checks and balances to make sure they were compliant sales. I think we were intelligent about not saying that the next customer who comes in you have to sell them this, if this is not what they want. Generically, this is one of the areas, on reflection, where there are risks, which we sought to mitigate.

Q446 Adam Tolley: One of the factors that the FSA has recently drawn attention to as a risk factor in relation to incentive schemes is that middle management or lower middle management might be under a conflict of interest in a situation in which the first line of defence is local supervision of more junior staff if the manager himself has an incentive to sell or for his staff to sell. It may be, therefore, that the diligence in reviewing the sales of more junior staff would be rather less than optimal.

Paul Geddes: That is not how I experienced it. It would concern a manager if one of his customer advisers were selling products that ended up causing a complaint, which we cared about a lot, and causing cancellations, which we monitored heavily. That is not a fair description of our culture, albeit that the risk of a points-based system is that we will all have outliers of poor practice and poor behaviour. We had a not insubstantial central team doing lots of exception reports, looking for areas of conflict and sales points got in the wrong ways, because ultimately those would be damaging both reputationally and financially.

Q447 Adam Tolley: It is interesting what you say. I wonder what typical type of management information you might have seen from time to time about the operation of the banks’ incentive schemes. Let us take front-line staff as an example. What kind of management information would be collated and produced for senior executive management on a typical basis?

Paul Geddes: I can help you with this. We frequently saw the level of performance and customer service indicators. The team who ran the branches had a team who, specifically ahead of the payment of every quarter, would be looking at all sorts of different exception reports and quality reports to cross-tabulate whether the results were achieved in appropriate ways. I think the checks and balances were there to be had. We had cross-tabulated customer satisfaction levels and customer complaint levels, as you would expect. I am explaining this, but I am not saying that it is a perfect system. Probably better than having checks and balances would be something at its heart that had more alignment with customer outcomes. We were very aware of the risks, and we did a diligent job to overcome them.

Q448 Adam Tolley: You have talked a number of times about the production of risk information for these kinds of incentive systems. Following on from that, how, when this was your responsibility, did you manage that risk of sales incentives for staff producing unfavourable outcomes for customers?

Paul Geddes: As I said, we had a system whereby we traced back where complaints went to and if we had people saying, "I don’t like this" we traced it all the way back to high cancellation rates. If risk and compliance was part of the overall performance management process, and if the performance management score went to two out of five, people were illegible for the bonus. There was a series of interlocking first, second and third line initiatives and processes around this. There were quite a lot of people involved. One of the benefits of having quite a specific but a large number of people doing the same thing is that you can very quickly do exception reporting and work out unusual patterns.

Q449 Adam Tolley: You also mentioned how incentive schemes might have been affected by the question of compliance with regulatory standards. I would like to know a little bit more about the detail of that. In particular, to take the example of a member of front-line sales staff, how would the bonus of such a person be affected by any assessment of his or her compliance with the regulatory standards?

Paul Geddes: Through the performance management process-again, you will have to forgive me the absolute detail-as I explained earlier, there is an appraisal process, and then there is an incentive payment process. The incentive payment process, as I said, had mechanical checks and balances to make sure it was not mis-sales. One of the means of appraising someone on how good they were at doing their job was the quality of their files and observations with various people in terms of witnessing a sales process. If somebody was shown to be poor at that, they would exit the bonus scheme while that happened.

The other thing to say is the appetite for helping someone sort themselves out and get better. We did have people who got these two ratings two years in a row, so I think the cultural thing, which was that suddenly something really bad happened to people who missed things, is not an experience that I have. The intention was either to help them get good at this job or find them something more appropriate to do, because sitting and talking to customers every day about products is not everyone’s preferred thing to do.

Q450 Adam Tolley: I appreciate that you have all moved on from the retail business since the relevant time. The bank’s submission to the Commission said that it has since taken-recently, since 2012-a range of measures aimed at making the group more customer-focused. I don’t know if any of you are able to assist on what those measures might be. There is no detail provided by the bank’s submission.

Paul Geddes: I don’t have the detail. What I can say in my own current business is that I think the FSA and particularly the FCA were absolutely right to put incentives clearly on to the table. I think that Martin Wheatley’s speech and the clarification yesterday is something that we take very seriously. As a board of my new company, there is a very active debate on the weighting of factors, the importance of factors and whether we are creating any evidence of perverse incentive for people to do anything other than the very best thing for customers. One of the big lessons from this whole thing is that this is an area that can be improved. It has been improved and will continue to be improved. I think it is a really good initiative by the FCA to get on to this.

Q451 Adam Tolley: Just concluding on this question of incentives, the clear message has been given to the Commission that there is either a total elimination of, or at least a significant reduction in, the role of sales incentives, in terms of bonus payments, or variable pay for staff related to volume of sales. Some of the evidence given to the Commission by and on behalf of the unions suggests that there may be an inconsistency between the elimination or reduction of volume of sales from positive incentives, while they are still being retained as an important factor in relation to what might we called negative incentives, in terms of performance management. Is that, to the extent you are able to assist, a reflection of the way things are going in the Royal Bank of Scotland group as well?

Paul Geddes: I am afraid I don’t have detailed or recent enough knowledge of it. I think those are useful comments. Unite does have a good dialogue in, and the views of it and its members are very relevant. From what I have heard, it was something that I was sure they were relaying back to their colleagues who were with us, and I am sure that they pay close attention to what they said.

Gordon Pell: The last few days have been a sort of return to commuting for me after three years. It has been useful in some ways. One of the things I saw is a recent paper from Stephen. I worked with Stephen Hester for some 20 months after the events of 2008 and was involved in some of the rebasing exercise that went on. There was a paper on incentives, where sales alone were effectively moved away from in terms of branch incentives and have been replaced by the concept of branch profit. So the branch manager would have his profit and, by definition, that of his staff, based on the concept of branch profit-its overall income, profit and bad debts.

I would welcome that, because that is what I grew up with during most of my career in Lloyds bank. The industry generally moved away from that though, because it is very difficult to administer. It is very difficult to allocate costs. If you can get it right, that is a much better measure, because at the end of the day, people have a more holistic view of what is going on in their business. But the industry moved away from that in the late ’90s. I would be delighted if we could find a way back to it with modern technology. I found it one of the more encouraging papers that I have had chance to read.

Q452 Adam Tolley: I want to move on to a different topic, which is regulatory compliance, the FSA, and the judicial review, so far as you are able to assist with that. On the general position of the FSA, Clive Briault, formerly of the FSA, told the Commission that the advice he would give to Martin Wheatley in coming to the FCA was that it would be wrong to assume that the financial services sector would willingly embrace the spirit of treating customers fairly. What would be your response to Mr Briault’s view?

Paul Geddes: I represent the general insurance industry on the Practitioner Panel, which will become the Practitioner Panel of the FCA, and I wholeheartedly embrace the intervention of Martin on a couple of levels. We have discussed incentives, and the other issue is a need for a much quicker and more straight-talking sharing of concerns and sorting out of issues, because it is to nobody’s benefit that things fester. On this notion that you can keep things going for some extra years, PPI proves that that is to no one’s benefit. It adds to the bill and reduces trust in the industry. One reason I invest time in monthly meetings with the FCA is to try and aid that sort of dialogue, and, when they are feeling worried about something, to try and get them to express it earlier.

The inception of the FCA is different, in that it does not have to get to such a level of worrying about something before they can share it with the industry, and it is wholly appropriate that they do so. From my point of view, the FCA is off to a very good and strong start. I think they have learnt the lessons of PPI from a regulatory point of view-which is earlier intervention-and the industry would be well advised to take the same view. I personally-I would not be on the FCA panel if I did not think this-take that view.

Guy Whittaker: Treating customers fairly is an absolutely essential building block in building a long-term, successful franchise. You need to have customers who trust you and come back to buy your products and services time after time. As a principle, I think it would be one of the foundations of any viable business in any industry, and in financial services especially.

Paul Geddes: Interestingly, having gone to investors recently to IPO a business, they are very interested in such questions as, "What do customers think of you?", "What do customers do?", "What are your loyalty rates?" and all those things. Therefore, this notion that the customer thing is something other than the investor agenda-especially in these times, where the front and the back of the papers are absolutely congruent-is a slightly outdated view of business nowadays.

Q453 Adam Tolley: Thank you. I come on to the question of the judicial review and particularly some of the comments you have made, Mr Geddes, about what you have described as the standards moving up in 2010. In other words, you have explained that there were the ICOB rules in 2005-we are familiar with that-and the ICOBS rules in 2008, and then what you say the bank understood as a moving upwards of the standards in 2010. That question was put to Angela Knight, who attended last week on behalf of the BBA, and she was asked about the BBA’s presentation that its members, and one would include the RBS group, held the legitimate view that there had not been widespread mis-selling of PPI prior to the outcome of the judicial review. She certainly, to some extent, wanted to disassociate herself from those comments and said that would not have been the way she would have put it. To what extent, do you, Mr Geddes, from what you have said already in this session, agree with the way that the BBA’s submission put it-that it was a legitimate view, prior to the outcome of the judicial review, that there had not been widespread mis-selling of PPI?

Paul Geddes: Let me try and help you in a couple of ways. I was on to Direct Line in the middle of 2009, so this was really not part of my consideration. I think that what is to be regretted is the elapsed time between when I left in 2009 and still this emerging picture of how we are going to deal with this issue. I have sympathy for the point of view that, unless you can have consensus on what the standards should be, getting that certainty is a useful step in working out what to do about it, because then you can work out what the remediation is. All the banks either decided not to meet the standards, or thought that the standards were different from what ended up being brought about at the end of 2010. It may have been that a single bank got it wrong, but for the entire industry to have missed it says that there was a level of uncertainty. Having got that certainty, it was regrettable how long it took, but at least that gave a backdrop for what subsequently happened.

Q454 Adam Tolley: The core issue was that the FSA took the view that one had to comply not only with the details that had been set out in ICOB and then ICOBS, but with the generality of the principles, and that the principles, such as treating customers fairly, added substance to the detail of the rules. The banks took a different view. To the extent that you can assist, Mr Geddes, and, perhaps ultimately you, Mr Pell, because you were in senior roles at the time, on what basis did the RBS group reach the view that it was acceptable to sell to the detail of the rules without necessarily complying with the underlying principle?

Paul Geddes: Again, I cannot assist you for this period, but I would like to give a very small example. My recollection was that the FSA wrote to banks to say that the disclosure of the cancellation term should be included in the written policy, but at that stage did not say, "and verbally disclosed." In the same letter it could have said, "and verbally disclosed." The whole industry thought that, by putting it in there and through the way it was read, that meant that that was the expectation. It was a subjective area.

Latterly, the FSA said, "Not only should you have done that, but you should have thought to do something else." Clearly, the whole industry missed that signal and interpreted it in a different way. Listen, I am not challenging the outcome of the judicial review, which found in favour of the FSA, but I am saying that I do not think it was an inherently invalid topic to seek clarity on, because now there is absolute clarity. There is absolute clarity of what it means, and I think that that will aid people in constructing sales processes to give people what they need, which is safety to move forward. That is helped by having the JR outcome. I am not saying that the JR outcome was wrong; I am just saying that it is useful to have it.

Q455 Adam Tolley: It may be that, in terms of the chronology, neither of you can assist with this question. Had the JR succeeded and the BBA won the judicial review, can you express a view-if you are able-on whether such an outcome would have assisted the restoration of trust and confidence in UK banking sector?

Paul Geddes: The exercise that I left on, which was in early ’09, would have been to go back and start to draft the questions we would ask the customer about whether we did anything wrong in their view, and then full restitution would have happened. The principle is that we needed to make amends for every incident where the customer was genuinely mis-sold to. There is the subjective judgment of what mis-selling looks like, which was then clarified, and it clearly assists a remediation process to have clarity on that topic.

Gordon Pell: I want to add a comment, because, again, I have looked back three years at this-I was not involved in the original discussions. I would very much have hoped that the industry meetings that took place in early ’09-the last time I was really involved in this-would have led to a very rapid conclusion and we could all have moved on. The reality is that there is a slight disconnect here. All our interfaces with the FSA were, going back to my earlier point, about building the foundations. Although principles may have been the issue, and we would certainly buy into those, the actual body language and the dealings with us were effectively about managing the sales process. It actually got down to, "This box ought to be this size, rather than this size." I think a lot of this could have been changed if someone had come in in ’05 and said, "We don’t need to go through any of that. We think, as a matter of principle 6, this is treating customers unfairly. Please explain yourselves." I have not found any documentation or approach that was that direct, at that time, from the regulator.

I have read the FSA’s submission to this panel, obviously. If there had been any paper that bore any resemblance to that or even 15% had looked like that, or if I had even been aware that it was being drafted in the FSA in 2005-06, then as far as I was concerned the product would have been withdrawn. It is as simple as that. I think there was clearly-at some point, you got the feeling that you were looking backwards as the industry jumped 6 foot, the industry jumped 9 foot, the industry jumped 12 foot and then someone turned round and said, "Well, that’s terribly interesting, but we’re now going to change the rules totally." By then, a very big hole had been dug. If there had been a much clearer intervention, a more forthright intervention, much earlier, probably this whole episode could have been terminated much more quickly.

Q456 Adam Tolley: Some of what you are saying, Mr Pell, suggests that the FSA had somehow endorsed the approach that the bank was taking to PPI sales. You are not suggesting that, are you?

Gordon Pell: There were a number of thematic reviews. They focused on sales management. They were relatively small scale. RBS-I can only speak for RBS, to be honest; I cannot comment on the industry generally-was never featured in any of those thematic reviews, except with comments that we could do something about improving our sales process, on which we worked very closely with them. There is a long letter from me to the FSA-I think at the end of ’06-that says, "Thank you for your feedback in this thematic review." We mystery-shopped with far more customers every year, in terms of our own testing of the process, than the FSA would have done in testing over a whole five-year period, simply because of our scale and the need to manage the process. There was no implication along that way, either verbally or in writing, that RBS was doing anything other than working satisfactorily towards a resolution of some sales-force processes.

I think that if in ’05 someone at a level of seniority in the FSA had come to me and said, "Look, we’re not going to pursue the route of this. We’re going to say that, as a matter of principle, we feel that this is treating customers unfairly, full stop," that would have effectively slammed on the brakes throughout the industry. I am not aware that happened. It certainly did not happen in RBS. During this process, a number of organisations were fined. One major bank suffered a major fine. Another major bank, I gather, went through a two-year extended discussion with the FSA. As far as RBS was concerned, it was never involved in any of these processes and maybe that encouraged a sense of complacency.

Q457 Adam Tolley: Are you inviting the Commission to conclude that it was essentially the FSA’s fault for not giving the banks more advice?

Gordon Pell: No, because, going backwards slightly, we run the business. This is primarily our responsibility. We have a whole series of checks and balances within the business. Then-this relates to Paul-there is the testing of systems and the response we get from customer complaints, which, remember, during most of this period were minimal. There is the operation of the banking ombudsman. It was finding 80% in our favour. There were very few dashes of purple smoke within our own testing process. We also rely on the feedback we get, as part of the process, from the banking ombudsman, from the FSA and from MPs’ post boxes.

There was more going on in ’05 and ’06, but I would not have said that it was as yet at a state where it actually stopped the industry in its tracks. Actually, to the extent that RBS got any feeling at all by looking at, for example, PPI growth in other businesses, we felt that, to the extent that there were issues with this business, we were definitely at the upper quartile end of what was going on, which provided me with a degree of reassurance in terms of standards.

Q458 Adam Tolley: Upper quartile for what?

Gordon Pell: Sorry, upper quartile for observance of whatever the standards of the day appeared to be. Clearly, there were issues, but I never got the impression that at RBS it was anything other than business as usual-I think those were the words Paul used. There was definitely a point in the middle of and even to late ’07 where there was a change in pace. We moved from green traffic lights and business as usual to-I would agree entirely-certainly to amber. In that process, we moved immediately to start discussing how we could discuss with the FSA some form of post-remediation review. We sat down with them. The problem at that point is they are not prepared to talk to you; they have to talk to the industry because they feel there needs to be an overall solution. You are into a very long process if that is the way they want to run it.

Q459 Adam Tolley: Just talking about when smoke signals became so clear, you have explained that banks ceased all sales of single premium PPI at the end of 2008. I think that you, Mr Geddes, explained earlier that that decision was taken because a view was formed that it was so difficult to advise compliantly in a single premium PPI case that the bank took the view that it could not sell them at all.

Paul Geddes: We couldn’t find an agreement with the FSA. It seemed that we could not sell to the emerging standards that were to be required, so we took the product off sale.

Q460 Adam Tolley: You continued to sell regular premium PPI policies for some time, yet, as I understand, sales of those policies ceased in September 2011. What I want to explore with you is what led you to think that sales of regular premium PPI policies could continue in circumstances where you had formed the view that sales of single premium policies could not.

Paul Geddes: Again, I only have a limited time frame. The priority was on the single premium, because of features such as cancellation. If it is a monthly premium, you can just cancel it. One of the features that ended up being quite problematic was the cancellation profile on period and disclosure, which was clearly not a feature of these products. There was a sense that the first place these complaint rates spiked and issues were expressed was on single premium. That was where we put the effort into. I cannot speak for what happened after the summer of ’09 on that.

Gordon Pell: Looking back, could I have done anything differently to minimise the effect on RBS of all this? Before late ’07, I do not think that there was real evidence from either our internal features or our external partners that there was anything other than a business-as-usual adjustment to the sales process. In retrospect, I really regret that I did not exercise my instinct and say, "This is all becoming too difficult for us to manage in terms of the relationship. It is damaging our relationship with the regulator, and it is clearly damaging our relationship with customers. The reputational tone is rising and we ought to withdraw the product earlier." In reality, we are talking about the six-month period during which sales were running at a very low level and the product was running off anyway. I certainly regret, however, not pulling it six months earlier. Would that have had a big effect on the financials? No. Might it have resulted in a bit of wake-up call to the industry if a major player had pulled the product? Maybe.

Q461 Adam Tolley: We know that HSBC substantially withdrew from the PPI market.

Gordon Pell: I think it would be fair to say that HSBC had its own issues. It is public knowledge that one of its major subsidiaries was fined significantly, and I had a discussion with its chief executive at the time. I go back to the issue that this was essentially about: some businesses seemed not to be that affected; therefore, we assumed that we were meeting the standards or were much nearer meeting the standards and had some hope of getting there. Some businesses clearly had much greater issues and no doubt had to make their own decisions.

Q462 Adam Tolley: You explained a moment ago that you considered the RBS group to be in the upper quartile of compliant sellers.

Gordon Pell: We received no indications to the contrary.

Q463 Adam Tolley: On what basis had you reached that view that RBS was in the higher quartile?

Gordon Pell: Because we had regular meetings with the FSA. Every time they visited the business, they would eventually have a meeting with Paul and then a final meeting with me. I do not remember any implication other than that we had a business-as-usual process going on and that we were fully constructive in working with them. There is a limit to which I can be psychic, because at this point none of our own indicators were flashing. The regulator felt that we were working with them and that there was a solution. I also mention the fact that during most of this process, the FSA were operating with a huge challenge and relatively limited resources. I remember that their panel was going through a cost-cutting exercise while all this was going on, which clearly cannot have helped. Our own regulators were changing regularly, so it must have been very difficult to deal with the industry from their point of view. I seldom saw the same person twice, simply because that was a challenge that they faced themselves.

Q464 Adam Tolley: Just going back to the comparison that you drew between the position of the RBS group and that of HSBC, did you take the view that you did not need to follow where HSBC had led, because HSBC was much worse than RBS?

Gordon Pell: No, because I had received no indication from the FSA that there was not a happy outcome-in other words, that we had reached a situation in which they said, "Yes, we are now happy with the sales process." At the end of the day, we were only dealing with the 10% or 20% of the journey that needed to be proceeded.

Q465 Adam Tolley: Did RBS group commission any external investigation of its sales of PPI?

Gordon Pell: We had endless checking processes going on internally. I am not sure how we would have done that, Paul.

Paul Geddes: Through 2008, on the basis of the FSA’s report, we looked not only at the customer outcome, but followed their mystery shopping. I guess we found some differences of opinion with the FSA-for example, on our saying, "You don’t have to buy this product," and their interpretation of that. That is why we came to the view that against what were clearly the expectations of mystery shopping, it was going to be hard for us to meet those, and that is why we took the product off sale and went for the past business review. I think it was external companies that we used through this period to do the satisfaction tracking for the 2005 and 2006 period.

Gordon Pell: There always seemed to be an outcome that was half a mile ahead of you on the road, and when you got to the end of the half mile, you found that you had another half mile. By ’08, it was clear that, almost whatever we did, we were never going to be able to reach a satisfactory point from that bottom-up process.

Q466 Adam Tolley: Just a few points of detail: the bank has indicated in its submission that moving away from a system that permits cross-subsidisation of one product by another might give rise to what the bank says are fundamental changes in pricing and charging structures. Are you able to say what the bank has in mind by that reference to fundamental changes in pricing and charging structures?

Guy Whittaker: I think I would suggest you go back to the author and ask for clarity on what they meant. I go back to my earlier comments. We have a model of free in-credit banking that ends up with a degree of cross-subsidisation. It might be a reference to that sort of activity.

Q467 Adam Tolley: Two final questions: the FSA has submitted to the Commission that the root cause of PPI mis-selling includes a culture within banks that exploited their position by the use of aggressive sales targets and complex product information. Do you accept that criticism in relation to RBS group? If not, why not?

Gordon Pell: I don’t recognise the accusation, and it was never made in any even diluted form during my entire time there.

Paul Geddes: That said, having sat through this whole series of events, I think it would be inappropriate for somebody now running a financial services business not to learn lessons. Those lessons would include the construction of the product and making sure that the product has the simplicity that is appropriate to the levels of sales expectations. Cultural incentives are another area where the industry has to reflect to make sure that there is synergy behind it. At the time, I think we acted in good faith in terms of acting on information, the interaction with the regulator and what we saw from customers. I think we acted in good faith, but it would be a very strange outcome of a process like this and a wasted opportunity if we did not learn from it. The only silver lining in all this is to learn, and I am absolutely committed to our new responsibilities. We need to work very differently with the regulator. We need to work on the cultural incentivisation of the industry. I am determined to learn from the lessons that there clearly are in this. But, as I said, at the time we acted in good faith.

Q468 Adam Tolley: This is possibly the last question. Clive Briault told the Commission last week that it was a "very reasonable conclusion" that the banks were prepared to move superficially in response to FSA efforts, but anything that would have interrupted the substantial flow of profits from PPI was resisted. To what extent do you accept that criticism in relation to RBS group?

Paul Geddes: I personally disagree. In Jon Pain’s testimony, he said that he did not think it was cynical, so I think we have two different viewpoints within the FSA evidence given to this Commission. Even if you took a cynical view, it would be a very strange strategy to elongate selling a product that would ultimately have to be refunded, because the sheer maths of it is the longer it goes on, the worse things are. When we came to the view that this needed to end, it ended. We then wanted to go and remediate it. It is an illusion that it is a good thing, on any measure, to elongate something like that. That is why I think the FCA’s much more proactive approach is entirely appropriate.

Q469 Adam Tolley: To conclude from what you have just said, is it your evidence to the Commission that the elongation of the process of trying to sort out the problem of PPI and its consequences for the banks has been inadvertent and not something that the banks foresaw at any stage?

Paul Geddes: Yes. If someone had said when I left the business back in 2009, "We’re going to be sitting in this situation at the beginning of 2013," I would certainly have wanted a very different outcome to that. I do not think elongation has any assets other than in achieving clarity.

Q470Chair: I know some of you are not in the business today, but when you look at the market, are there any products, regarding mis-selling or cross-selling, that you have concerns about and want to bring to our attention as a Commission?

Paul Geddes: I am now in the general insurance marketplace. There are a couple of products we are proactively discussing with the FCA. As I explained to Mr Tolley, that is a different sort of dialogue. It is much earlier in its construction on a couple of insurance products, which is to be absolutely encouraged.

There are features of the motor insurance marketplace that I have actively campaigned to have reviewed at industry level. On the practices around referral fees and bodily injury, I have made personal representations to Downing Street, and we lead the lobbying for change in that area. We think high legal costs and referral fees are a bad thing. We were positive about the motor insurance sector’s referral of the practices of garage repairs and credit hire. I am very positive about early intervention on characteristics of industry that are inefficient and lack transparency. We have pushed all those issues in to appropriate regulators to deal with, and our interaction with them is very proactive.

Q471Chair: For example, on ID theft, insurance and car protection plans, those products claim to offer cover for unauthorised transactions if the consumer’s debit or credit card is lost or stolen. However, it has been put to us that consumers are largely covered already under existing legislation and were never liable for transactions after they had notified the bank that their cards had been lost or stolen. Do you think products like that are in the consumer’s interest?

Paul Geddes: One of the product categories that I continue to work with the retail bank on in my new job is package bank accounts. If I may use that as an example of the desire to make sure that these sorts of products-at the margins, these particular products are not ones that I am close to, but one of the things we have worked very constructively with the retail bank on is removing having two products in a product suite where the customer might have both. We have taken, for example, travel insurance away so that it cannot be bought at the same time as a package account which includes it. We have removed any vestige of products which needed prior registration-

Q472Chair: The Treasury Committee six years ago recommended that. It was only when the politicians put pressure on that that happened with the travel insurance. Maybe you can understand our frustration when we highlight issues and then it is seen as a victory for the industry six or seven years later, when they have been dragged along to change on that issue.

Mr Pell, Jayne-Anne Gadhia gave the following quote to the panel on retail competition: "I used to work at RBS until seven years ago, and at the time I was working in an area that was selling PPI. I spoke to a senior person at RBS about the need to withdraw PPI from our marketing, and the reply I got was, ‘Yes, it is clear that that should be withdrawn, but we cannot be the first people to do it, because we would be the ones who lose profit first.’" Do you recognise that sentiment?

Gordon Pell: No, to be honest. I do know Jayne-Anne personally; I saw her only a couple of days ago. I imagine she would have raised it with me.

Q473Chair: So she is flying a kite?

Gordon Pell: No, I am sure she would have made that comment. I would actually agree with a slightly different comment, which is-

Q474Chair: What is interesting here is the culture. Here is Jayne-Anne Gadhia coming in and telling us this happens, and here are you in a senior position at RBS, but never the twain shall meet. It doesn’t seem as if there is a homogeneous culture there if she on the one hand is saying this-people are saying, "No, we can’t do that, because we will be the first to withdraw from the market," and you are saying, "No, I don’t recognise it at all. That is another world."

Gordon Pell: I am sorry, but-

Q475 Chair: You can understand our confusion if we are looking at a single corporate entity and we get two points of view like that. Would you agree, Mr Geddes?

Paul Geddes: Would I agree?

Q476 Chair: In other words, our situation, where we don’t know what to think, where we get two senior executives from the same organisation, one telling us that they told him to withdraw the product, and the other, Mr Pell, saying "I don’t recognise that sentiment at all."

Gordon Pell: I am just trying to drag my mind back slightly. Jayne-Anne was actually in charge of our mortgage business, where the only real product we would have sold-

Q477 Chair: No, she spoke about PPI here.

Gordon Pell: I was just trying to think in what context she might have been talking.

Q478 Chair: We are trying to reconcile different points of view here, and I mentioned to you earlier on about the FSA. I’ll give you a quote from the FSA that I was informed of directly from a very senior person in the FSA: "Regarding PPI in our processes, when we looked at it, it wasn’t that we didn’t notice it. We told them to stop doing it, but the banks said, ‘You’re not making your case. Go back and do more.’ We went back, did nine months’ work, then went back and fined them." It goes on-and I’ll finish-"We recently looked at incentive structures in the financial industry. They were atrocious. The levels of control and conflicts regarding commission were scandalous. For example, one scheme we looked at regarding PPI required an 80% penetration rate. If the individual didn’t attain that, the bonuses for other products went to zero. The result: huge PPI sales." Again, do you recognise that?

Gordon Pell: No, I’m sorry; I don’t recognise it with RBS. I can only speak for RBS. As I said before, the maximum we would have achieved as a business would have been 50%. At 80% clearly I would have been really interested in what was going on within that business unit, for reasons I have already discussed.

Q479 Chair: Fine. I think you will help us understand our misunderstanding. I think that has been helpful to us in that regard.

Gordon Pell: Yes, well, we tried to.

Chair: We have been here for three hours. It has been very helpful. The aim of this session was to take evidence which will inform the main Commission when others come along. I think the evidence you have given to us this afternoon has been very helpful, so thank you for your attendance.

Gordon Pell: Thank you very much for the opportunity.