Parliamentary Commission on Banking StandardsWritten evidence submitted by the Co-Operative Banking Group

0. Response Precis

(i) Co-operative Banking Group (the Bank) welcomes the opportunity to respond to the Parliamentary Commission on Banking Standards. Further to the Bank’s response of 13th December in which we provided a list of Payment Protection Insurance (PPI) decision makers from 2000 to 2012; in accordance with your direction, we now enclose the Bank’s detailed response to your fuller data request.

(ii) Whilst this response does represent a thorough and considered reply to the questions posed, it has been compiled within a short timeframe. As such, the Bank reserves the right to expand upon the content of this response, should further relevant information come to light moving forward.

(iii) Elements of this response refer to communications, meetings and/or engagement with the FSA which are confidential, and in some cases explicitly subject to confidentiality obligations. The Bank has endeavoured to provide full answers to the Commission’s questions, but nothing in this response should be taken as any waiver of confidentiality by either the Bank or the FSA in relation to documentation referring to these or to the communications themselves, and the Commission is asked not to make the content of these statements publicly available.

(iv) Similarly elements this response reference the considerations and decisions of the Bank’s Board and its sub-committees. The information provided in these paragraphs is by its nature confidential and commercially sensitive; whilst it has been provided to the Commission to assist, as above, nothing in this response should be taken as any waiver of confidentiality, and the Commission is asked not to make the content of these paragraphs publicly available.

(v) As requested by Colin Lee on 6th December, the Bank’s response accords with the timeline mentioned in the written evidence from the FSA to the Panel and agrees with several of the key messages highlighted by the regulator. However, there are some areas of difference, which are commented upon throughout the document.

(vi) The Bank and its predecessor organisations, have always intended and endeavoured to treat customers fairly and sell products compliantly to the regulatory regime in force at the time. From the announcement of the ICOB rules in 2004 the Bank initiated a project to implement them, electing to sell PPI on an advised basis (for face to face and telephone sales channels) in order to provide better safeguards for customers. Over subsequent years the Bank had repeated engagement with FSA and other stakeholders, to revise and refine how PPI was being sold.

(vii) Looking back through the chronology set out in answer to Question 1 below, it is striking just how much engagement internally and externally took place, and indeed how much time and effort was spent trying to get it right. The Bank implemented multiple initiatives, shared outputs and remedial action plans repeatedly with FSA, agreed promptly to take additional actions (including a past business review of its branch salesbetween 2007 and 2009), and received some feedback from FSA suggesting that the Bank was indeed focussing on the right priorities and attending to the right things. Yet, plainly ultimately all banks fell short of what the regulator wanted.

(viii) Reviewing the material collated to respond to this data request it would appear that the banks’ understanding/interpretation of what was required was incomplete, and equally that the FSA’s expectations (tests) of how the right outcomes were to be demonstrated were not sufficiently transparent or stable.

(ix) The Bank feels this is a vital area to get right going forward, as we have no appetite to repeat the PPI experience again.

(x) Looking forward the Bank plans to adopt an extremely cautious stance in relation to conduct risk, as structural constraints on mutuals accessing capital markets mean that we cannot risk further financial and reputational uncertainty resulting from mis-selling.

(xi) The Bank has a strong desire to become a real challenger to the major PLC banking groups. The Commission will be aware of the huge efforts we are making in relation to the Verde transaction (ie the purchase of some Lloyds Banking Group branches and related customers). If successful, we are hopeful that the acquisition of the Verde assets will equip the Bank to become a genuine alternative in the market for customers.

(xii) However, for the Bank, and perhaps the market as a whole, there needs to be a better way for banks and regulators together to improve outcomes for customers without risking a repeat of the PPI journey since 2005. Greater precision about both the outcomes required and how they should be evidenced would seem to us a desirable goal, together with wider structural actions to improve competition. As a small bank it has been impossible for the Bank alone to reshape market practices or to materially affect value flows between customers and their banks.

(xiii) Linked to this, sufficient time needs to be allowed for banks to implement required improvements, such that we can get it right first time, and not repeat the PPI experience of rework upon rework.

(xiv) The Bank’s approach to treating customers fairly has developed significantly over the period of review and will continue to do so. However, care must be taken to ensure that appropriate and relevant customer offerings are not removed from the market for fear of uncertainty of retrospective action. Considerable thought and care will be needed to enable UK retail banking safely to make the necessary changes at a time of extreme environmental stress without harming the service we provide to customers. The Bank is committed to providing products and services which customers both want and need moving forward.

(xv) The Bank looks forward to seeing the results of the Commission’s deliberations.

1. Summary of the history of PPI sales at your bank from origination of the idea to now (including a tabular chronology of key events). Please specify key decisions that were made by; product development or product approval committees, risk or compliance committees, internal audit committees, Senior Executive committees, Board committees and the main Board. Please also specify the date of these meeting and chair of the meeting.

(i) Introduction

1.Co-operative Financial Services was created in 2005 when the Bank merged with Co-operative Insurance Society.

2.In 2009 Co-operative Financial Services merged with Britannia Building Society.

3.Co-operative Banking Group was created as a name change from Co-operative Financial Services.

4.Britannia Building Society sold mortgages and mortgage payment protection insurance (MPPI) post and pre-merger. Britannia formed a joint venture with Halifax Bank Of Scotland (HBOS) in 1998 to sell unsecured lending products (loans or credit cards) and associated PPI. HBOS were responsible for sales processes and documentation of all unsecured products and PPI.

5.Co-operative Bank introduced PPI products from 1980 for loans, 1987 for credit cards and 1993 for overdrafts. Mortgage payment protection insurance was introduced from 2000.

6.Given that industry and regulator concern has mostly been focussed on PPI on unsecured products, particularly single premium PPI sold with loans and Britannia’s limited involvement via the joint venture with HBOS, this submission predominantly focuses on Co-operative Bank activity. On this basis the document will refer to all entities as the Bank unless for clarity specific entity names are required.

(ii) PPI products were introduced from 1980 onwards, these products were originally underwritten by Co-operative Insurance Society. Given the elapsed time since these products were launched little information is available about the governance and approval processes at the time.

(iii) In 1993 competitive tender exercises were undertaken and the manufacture of unsecured PPI products was outsourced to Royal & Sun Alliance and London & Edinburgh (Norwich Union).

(iv) Prior to 2005 PPI was regulated under General Insurance Standards Council (GISC) and little information is available, although it is known that independent monitoring against GISC standards was undertaken and in October 2003 a report by1 PwC identified corrective actions.

(v) In January 2004 the FSA published final ICOB rules and the Bank initiated a project to implement the rules and elected to sell PPI on an advised basis in face to face and telephone sales channels (internet sales were non-advised).

(vi) ICOB sales practices were implemented from January 2005 and sales monitoring amended to test compliance with the new rules. The Bank quarterly Internal Audit report to 30th April 20052 was presented to Audit and Risk Committee in June 2005 (chaired by Graham Harold Stow) and it was noted that the Customer Services—Administration of Bank Loans Report3 was graded as unsatisfactory and included the recommendation that there should be increased control over sales procedures for loan repayment insurance where older customers were involved.

(vii) In November 2005 the FSA published the findings of its first thematic review of PPI and issued a “Dear CEO” letter.4 It is from this point on that information becomes more readily available. The Bank CEO responded5 in December 2005, confirming that post ICOB internal monitoring had identified some areas of further improvement; and confirming that a wider end to end review of sales, servicing and claims processes had been initiated and seven short term areas for improvement were highlighted and undertakings given. This work was managed through the Creditor Protection Review reporting through a steering committee with regular updates to Board commencing in April 2006.

(viii) In March 2006 a process was put in place to identify customers who had reached the age of 70 (become ineligible for cover) and cancel their policies, refunding the unexpired portion of single premium cover, and stopping payment on regular premium policies.

(ix) Improvements were made to sales processes from May 2006 to improve eligibility assessment and ensure it was adhered to. An eight week monitoring review was undertaken to test the effectiveness of the changes, by the end of the review standards were 93% compliant with the new process.

(x) The Bank was not selected to be visited by the FSA in connection with its second thematic review of PPI; and had not been visited during the first thematic review in 2005. The Bank believes that, at this stage, it did not have the benefit afforded to other financial institutions with whom the FSA was discussing its emerging thinking on PPI issues and concerns. On 8th June 2006 the Bank met with the FSA to discuss PPI progress on the short term actions agreed in the Creditor Protection Programme. FSA suggested6 that the Bank response to the “Dear CEO” letter highlighted 3 “outlier” issues for us namely:

1.Weaknesses in eligibility identification.

2.Use of a standard rather than customer specific Statement of Demands & Needs.

3.Lack of balance between explaining benefits and exclusions.

(xi) At the meeting the FSA also confirmed7 it was looking for firms to embed suitability into the sale of PPI, and suggested the Bank started to implement in advance of the FSA publishing their requirements in the thematic review report (published in October 2006). The Bank registered that given the requirement for system development to support suitability assessment and recording, it would be preferable to have clear guidance from the FSA on the requirements so that a strategic solution could be achieved rather than a series of ad hoc changes.

(xii) Further information on sales monitoring, sales scripts, Statement of Demands and Needs and management information were shared with the FSA in August8 and October 2006.9

(xiii) In December 2006 the number of advisers selling PPI in the branch network was reduced from 400 to 200 in order to allow for greater control of the workforce. At this point training of advisers in new suitability processes and tools commenced, prior to its introduction in March 2007.

(xiv) In February 2007 the PPI pricing review, part of the Creditor Protection Review, implemented a 20% reduction in the price of PPI products. Refunds policy for single premium PPI was also changed to “rule of 78” in line with the FSA recommendation in the second thematic review report, giving a customer greater refund for early cancellation.

(xv) In March 2007 the Bank implemented a suitability assessment tool and revised disclosures across all advised PPI sales channels. This was supported by training and competency assessment and followed up with further monitoring.

(xvi) In May 2007 the FSA undertook a visit to the Bank as part of its third PPI thematic review, meeting individuals responsible for the product, distribution and compliance and interviewing sales advisers.

(xvii) Commencing in May 2007 the Bank undertook a review to test whether the newly introduced suitability assessment process would have delivered different customer outcomes for customers who had bought PPI under the previous sales process. All 2,211 customers who had purchased loan PPI between January 2007 (January was the originally planned date for implementation of suitability assessment) and March 2007 were contacted. 632 customers responded to the review and only nine cases were identified as unsuitable and four ineligibility issues were identified, suggesting no systemic failings at that time. These results, along with PPI penetration rates by channel, which indicated that “no major shift in PPI penetration rates were experienced around Period 3” (March 2007 implementation date), were shared with the FSA in November 2007.

(xviii) Further PPI sales training was implemented for contact centre advisers and supervisors between August and November 2007.

(xix) Feedback on the FSA visit on 16th and 17th May 2007 led the Bank to believe that it was favourably placed with regard to PPI selling relative to other firms they had reviewed. Areas of concern were:

1.The delay in implementing eligibility and suitability assessment against the ICOB requirement.

2.The explanation of the implications of single premium policies—the premium being added to the amount of the loan and interest charged on the premium throughout the term of the loan.

3.The burdensomeness of the loan application process if the customer did not want PPI.

(xx) A detailed response10 was provided to the FSA on 16th November 2007 which highlighted the following key actions either taken or planned:

1.An end–to-end monitoring review of PPI sales (Q1 2008).

2.Changes in PPI claim handling for sales from 2005 and a review of claims previously rejected from these sales (implemented 2008).

3.Improved contact centre sales training (Q4 2007).

4.Implementation of a dedicated contact centre loan and PPI team (Q1 2008).

5.A revised disclosure script (November 2007).

6.Streamlining the loan sales process for customers not wishing to purchase PPI (Q1 2008).

(xxi) A revised disclosure script11 was implemented in November 2007, clarifying the impact of single premium.

(xxii) In December 2007 the FSA published its final ICOBS rules transitional implementation from 1st January 2008–30th June 2008.

(xxiii) In January 2008 further enhancements were made to the training and competence scheme for PPI including the implementation of risk based Quality Assurance (QA) reviews in addition to randomly selected QA reviews.

(xxiv) On 6th February 2008 following a change in the FSA supervisory team responsible for the Bank the FSA responded to the Bank response (of 16th November 2007), raising concerns about its ability to prove the suitability of historic PPI sales. Communication with the FSA continued between February and June 2008 on the issues raised.

(xxv) In March 2008 ICOBS was implemented in the Bank.

(xxvi) In March 2008 Risk Committee (chaired by Simon John Butler), Shareholder Asset & Liability Committee (chaired by David Anderson) and the Bank Board (chaired by Robert Henry Burlton) were presented with the Bank Capital Plan12 which included a potential claim on free shareholder capital of £120m post Tax (£170m pre Tax) for PPI charges.

(xxvii) An annual competence sign off process was introduced for branch advisers selling PPI, along with additional control by branch managers monitoring PPI sales on a weekly basis.

(xxviii) A dedicated telephony loan and PPI team was implemented in May 2008 which reduced the number of telephony advisers selling PPI from 600 to 150.

(xxix) A sales incentive scheme (ST*RS) was launched for branch and contact centres in July 2008 directly linking payment to competence and service standards to encourage correct behaviours. A branch incentive scheme had previously been in place July 2002 to June 2006.

(xxx) Audit & Regulatory Compliance Committee (chaired by Graham Harold Stow) on 9th Sept 2008 received a report13 on a review of PPI sales in the branch network which noted a number of shortcomings in terms of process requirements not being met, managerial checks not being completed, insufficient monitoring of PPI penetration rates and that competence of individuals selling PPI had not been adequately maintained. It also noted that a programme of remedial actions had been implemented and progress made in all areas.

(xxxi) During October 2008 proposals for replacing single premium with a regular premium product in 2009 were shared with the FSA. At this meeting it was discussed14 that if the Competition Commission recommended the decoupling of PPI sales from the time of the loan sale it was likely that the Bank would withdraw from the PPI market for loans. It was also noted that continuing to sell single premium PPI post 2008 was not in itself seen by the FSA as a deal buster, ie the Bank’s plans to continue selling single premium PPI until the launch of regular premium were deemed acceptable by the FSA.

(xxxii) A review of recorded telephone sales was undertaken by the Compliance monitoring team and an independent mystery shop by Research First was commissioned by the Bank, the results15 of which were markedly better than those reported in the FSA’s “Payment Protection Insurance—A Thematic Update”16 on 30th September 2008.

(xxxiii) In December 2008 the FSA requested17 firms to stop selling single premium PPI by 31st January 2009. The Bank agreed18 and stopped selling single premium PPI on 5th January 2009. In this letter the Bank also provided “details of the actions that have been undertaken regarding PPI sales since receipt of the ‘Dear CEO’ letter in late 2005” and commented “we have concluded that in combination these various developments (cessation of sales of single premium PPI and the Competition Commissions provisional remedies) are highly likely to render payment protection insurance (regular or single premium) difficult to sustain economically going forward”.

(xxxiv) In February 2009 the FSA shared its mystery shop findings19 with the Bank and the Bank agreed to undertake its own past business review of branch based single premium PPI sales between July 2007 and January 2009. It is clear from the FSA’s explanation of how sales failings were assessed20 that it had defined specific detailed criteria based on FSA principles, not just the ICOB and ICOBS rules.

(xxxv) Past business review plans shared with Audit & Regulatory Compliance Committee21 (chaired by Graham Harold Stow) and FSA22 23 in March and April 2009 respectively.

(xxxvi) In September 2009 the FSA PPI team informed the Bank that it was proposing to issue a consultation paper on PPI complaint handling (CP23/09) in September 2009 and it was mutually agreed that due to the uncertainty that this would create and the risk that the proposed past business review activity would not meet the standards that would be defined at the end of the consultation, the Bank should put its planned implementation of past business review activity (due to commence in September) on hold. This was confirmed with the FSA’s Bank supervisory team.24

(xxxvii) In November 2009 the Bank ceased new sales of regular premium PPI on credit cards and overdrafts.

(xxxviii) An update on developments in PPI was presented to the Bank Board (chaired by Robert Henry Burlton) in December 2009,25 covering:

1.The regulatory developments around PPI complaint handling.

2.The potential financial implications.

3.The Bank’s plans going forward, including the recommencement of the past business review preparation work in November 2009. (xxxix) In the anticipation that the FSA would publish a policy statement on PPI complaint handling in early 2010 a second project to undertake the past business review requested by the FSA as a result of their mystery shopping commenced in November 2009. The work was again put on hold in June 2010 because of the continued uncertainty around standards for undertaking the review. This postponement of the past business review was agreed with the FSA.

(xl) The FSA published PS10/12 in August 2010. The BBA response to the Commission sent by A Brown 17th December 2012, said that this finally cleared up the overlap between the statement and the handbook guidance, that had been on-going since the beginning of 2008 (reference BBA letter paragraphs 17 and 21).

(xli) The September 2010 Board (chaired by Paul John Flowers) received a PPI update paper26 that covered the developments with FSA in terms of complaint handling policy (PS 10/12) and the potential BBA response. The Board agreed to:

1.Continue to handle complaints in line with the existing policy ensuring that where the Bank had caused customer detriment it was corrected.

2.Support the BBA approach to challenging FOS and FSA [referring to the Judicial Review].

3.Update past business review implementation plans to take into account the requirement of the FSA policy statement, but not to commence implementation until the outcome of the BBA action is clear.

4.Review the financial assumptions for PPI.

(xlii) The October 2010 Board (chaired by Paul John Flowers) meeting was informed of the BBA application for Judicial Review of the FSA and FOS; and a PPI update paper27 was presented to November 2010 Board detailing:

1.The actions taken by the BBA.

2.The likely timetable for legal proceedings.

3.The Bank and industry approach to complaint handling during the Judicial Review.

4.The potential cost of redress and the approach to dealing with potential redress in year-end accounts.

(xliii) From February 2011 further internal discussions were held about potential provisioning for PPI, it was decided and agreed with the auditors, that there was not sufficient certainty to make a provision in the 2010 year end accounts. In May 2011 following the Judicial Review judgment and the BBA decision not to appeal, a paper28 was presented to the Chairs Committee (Extraordinary Board chaired by Paul John Flowers) on 16th May and a provision of £90 million was made on 17th May. It should be noted that during deliberations about the correct size of the provision it was discussed with the FSA and the Bank’s initial estimate of £180 million pre Tax was challenged by the FSA as overstated.

(xliv) Following the ending of the Judicial Review the Bank provided full final responses including detailed redress offers, where appropriate, for all PPI complaints that had been stayed during the legal process by the required deadline of 31st August. A PPI Executive Steering Committee29 was established from August 2011 to provide input and oversight to the way that PPI remediation was being planned and delivered, and to provide final sign off for policies used in remediation. At this stage all complaints with a policy were paid out in full, with 8% interest applied as required by DISP.

(xlv) Regular updates and management information were provided to the FSA from May 2011 onwards.

(xlvi) In February 2012 a further update30 on progress and plans for PPI remediation was presented to the Board and it was agreed that no change was required to the existing provision in the year end 2011 accounts.

(xlvii) Following a rapid increase in the volume of PPI complaints in the first quarter of 2012 the PPI provision assumptions were re-evaluated and in June 2012 a £30 million increase in the provision was recommended to Board.31 In July 2012 this was increased by an additional £10m following further discussion with external auditors in light of the continued high complaint experience and competitor experience. Expenditure against the provision and trends in the key drivers of the provision are monitored and the adequacy of the provision reviewed regularly.

(xlviii) In October 2012 the Bank commenced past business review activity on a cohort of customers impacted by eligibility issues.

(xlix) In addition, the Bank agreed at this time to the FSA’s August 2012 request32 for firms to voluntarily review PPI complaints that had been rejected between 2005 and the implementation of the FSA policy statement on PPI complaint handling (PS 10/12). This review commenced in November 2012 following a discussion with the FSA on the Bank’s go-forward complaint processes. Plans are in place to undertake further past business review activity during 2013.

2. An organogram outlining how the above referenced committees link to each other and link to the board.

(i) The organogram below illustrates how the committees referenced with Question 1 link to each other and the Board.

(ii) Pre 2002 the Bank had its own Audit Committee (in addition to a number of other Committees such as an Advances Committee and a Remuneration Committee—none of which would have considered the sale of PPI).

(iii) In 2002 the Bank formed the Audit & Risk Committee.

(iv) In 2006 the Audit & Risk Committee split into two separate Committees—the “Audit and Regulatory Compliance Committee” and the “Risk Management Committee”.

(v) In 2011 the Committees were renamed the “Audit Committee” and “Risk Committee”.

(vi) In 2012, although it has not changed its name, the Risk Committee has become known as the “Board Risk Committee” as there is now also an “Executive Risk Committee” (consisting of Executive members only).

3. A summary of how your bank sourced the PPI product(s) it sold (for example, were they manufactured in-house, through a joint venture or via a third party?) and describe how this may have changed over time.

(i) Dependent upon legal entity and policy type, the Bank has, since 1980, adopted a sourcing approach that has included both in-house and third party suppliers. Table 1 below illustrates how these sourcing relationships have changed over time.

4. Please summarise the training that was in place for all staff selling PPI and through a tabulated chronology how this may have changed over time.

(i) Table 2 below, based upon corporate memory and available documentation, details how training across the Bank has been impacted by the introduction of ICOB in 2005 and subsequent changes to sales processes driven by the Creditor Protection Review.

 

5. Please summarise any incentive schemes that were in place for all staff selling PPI and through a tabulated chronology, if appropriate, how this may have changed over time. Please explain to what extent Executive Director and Senior Executive incentive schemes were impacted by PPI sales and how this may have changed.

(i) A branch network incentive scheme was introduced in July 2002; call centres were excluded from incentive schemes until 2008. The scheme covered other products in addition to PPI.

(ii) Individuals who exceeded their target received an incentive payment calculated on a quarterly basis. From the data available the median average quarterly incentive payment, for those receiving a payment, was £158 (1% of salary) in 2006.

(iii) The scheme was withdrawn in June 2006 and a full review of incentives undertaken prior to the introduction of a new scheme in 2008.

(iv) The ST*RS incentive scheme was introduced in 2008 for branch and call centres, which included PPI. Annual reward levels from the scheme remained low ie in the low hundreds of pounds. From the data available the median quarterly incentive payment, for those receiving a payment, was £320 (2% of salary) in 2009.

(v) The following information summarises reward principles and general approach to variable pay, bonus and balanced scorecard methodology:

1.The general structure of remuneration in the Bank is such that it is designed to align with the values of the organisation. Levels of variable pay opportunity are modest, consistently set at levels lower than in other banks. Base salaries are set at a level which is market aligned and which are therefore sufficient to allow for the possibility of no bonus being paid in circumstances where performance does not warrant such a payment. The construct of both the annual and long term bonus plans is based on a balanced scorecard that includes significant non-financial measures which ensure that there is no encouragement of inappropriate risk taking.

2.Annual Incentive Plan “AIP” (firm-wide scheme). Designed to incentivise and reward all employees for the achievement of the annual business plan as encapsulated in the Bank balanced scorecard.

3.The Long Term Incentive Plan (LTIP) (Executive & senior management). The plan is designed to focus and align the leadership team with the long term strategy of the business. The plan measures performance over a three year period.

4.The Bank does not follow a bonus pool approach. Awards under both the AIP and LTIP are determined in accordance with balanced scorecard performance. Remuneration & Appointments Committee members approve individual awards post external audit of the balanced scorecard results.

5.The AIP Plan covers the vast majority of employees within the business (circa 10,000).

6.Bonus will only be paid if the balanced scorecard underpins are achieved. Performance targets are based on financial and non-financial targets. Underpins are a set of criteria encompassing profitability, compliance with risk parameters, capital and liquidity sufficiency. In addition if an individual’s performance is unacceptable, no payment is made.

(vi) Historic Practice.

1.Single premium PPI sales activity ceased in January 2009.

2.Annual and long term bonus schemes in operation from 2009 to present date have no profits materialising from PPI sales.

3.2002–08 records do show that PPI sales results were incorporated within the overall firm wide Bank Profit numbers. PPI sales were not isolated as a separate product line; however the sales did feed into the overall firm wide profit results.

4.Contribution from PPI will therefore have had an impact on bonus levels on the basis that profit was a bonus measure.

5.The materiality of PPI contribution started to decline from 2003, with a significant drop post 2006.

6.Annual and long term bonus architecture has changed over the years, however a balanced scorecard approach has consistently been applied, inclusive of financial and non-financial measures. Heritage Britannia also followed a balanced scorecard approach, with Profit only accounting for 20% on overall award in 2009.

7.Annual and long term bonus opportunity is modest comparative to competitors within the financial services sector; in line with the Co-operative Values and Principles and limiting variable pay.

8.2011 AIP outturn was reduced by 10% and 2009–11 LTIP outturn reduced by 15% for the Bank Executives in light of PPI. The Remuneration & Appointments Committee did take the decision to discount awards due to reflect the impact of PPI on the financial performance of the business.

(i) A high level overview of Executive Annual Bonus Schemes is detailed in Table 3 below, which show Total Bonuses paid are relatively small. Information is taken from historic Remuneration & Appointment Committee meeting minutes.

6. With regard to the finances of the PPI product, please describe income, costs (including claims) and thus product profits. Please use a tabulated chronology, if appropriate, to show how this may have changed over time.

(i) The Bank does not have historical cost allocation methods and data covering the period in question. As such, we cannot present this breakdown as requested. However, the PPI income and claims ratio information are provided in the Data Tables in Appendix B as requested by the Commission and is considered a relevant proxy.

7. How far was development of this product originally influenced by wider public policy objectives? Where a public policy objective did exert influence what did your bank perceive that objective to be?

(i) The Bank is not aware of wider public policy objectives beyond the mortgage market.

(ii) During the time period covered by this review, if customers fell ill, suffered a serious injury, or became unemployed for any reason, they would not qualify for state help with mortgage repayments until nine months after making a claim and then they would only receive this support if they qualified for income support. Dependent on individual circumstances and resulting state help, there was also a reasonable chance that a customer would not receive the full amount of their mortgage repayment. As a result of this, the government worked with the Council of Mortgage Lenders to encourage customers to take out PPI policies to cover circumstances when they would not be covered by benefits.

(iii) In 1999, The Council of Mortgage Lenders, with support from the association of British Insurers and the government set a target of 55% for the take-up of mortgage payment protection insurance (MPPI). This was later withdrawn in 2003, after the CML reassessed its sustainable home ownership initiative.

(iv) The CML target was understood to assist with sustainable home ownership through the provision of an appropriate safety net for customers. The Bank did not sign up to achieving this target.

(v) The over-riding objectives in providing an MPPI product were to provide an insurance solution to the risks of mortgage payment default as a consequence of accident, sickness or unemployment and prudent business management.

8. What were the perceived consumer benefits of PPI and who were the perceived beneficiaries?

(i) In the context of offering PPI the benefits, were that in the event of being unable to work as a result of accident, sickness and/or unemployment, the policy would provide cover to meet the monthly repayments required by the lending contract.

(ii) The perceived beneficiaries of these products were those customers who either did not have adequate alternative means to meet their repayments in the event of accident/sickness and or unemployment, or if they did, preferred not to rely on them to cover the costs. Access to long term savings is an example of this. As such, the products were considered to have a broad appeal and address specific customer protection needs.

9. What information sources or controls were in place to monitor whether PPI was being sold appropriately? How, if at all, did this change over the period 2000 to 2012, and did these processes identify that PPI was being mis-sold?

(i) A series of controls were established to undertake monitoring of PPI sales. These included both regular reviews of sales and specific monitoring exercises to assess the effectiveness of the implementation of changes to the sales process.

(ii) The changes to sales processes were as a result of the Creditor Protection Review set up as a result of the “Dear CEO letter” received in December 2006, where required improvements to the Bank’s processes were highlighted. Additional controls were established to validate that the required changes, initially eligibility followed by disclosures and suitability, could be evidenced as having taken hold within the Bank. Table 4 below details the key control enhancements during the period in question.

10. At any stage did the bank decide to review PPI mi-selling? If so please describe the nature of reviews, ie how reviews were conducted, by whom what conclusions were reached and what changes were made. With regard to any changes to the way PPI was sold please identify the decision making body and its chair.

(i) In hindsight there were clearly sales made that ought not to have been. The Bank’s understanding and actions to mitigate evolved over time as the industry, regulator and its own assessments developed, as recorded in Question 1.

11. What actions were taken in response to external reports of mis-selling by such as WHICH?, the FSA and FOS?

(i) In response to external reports such as the FSA’s first thematic review report (November 2005) which also resulted in a FSA “Dear CEO” letter being sent to firms in November 2005, the Bank committed to a series of actions which included strengthening sales process and scripts, reviewing potential system enhancements to identify triggers for ineligibility, enhance utilisation of MI such as complaints and claims.

(ii) To meet these commitments the Bank initiated a Steering Group in December 2005, comprising of senior managers representing operational and supporting areas to direct and oversee progress through a project. In addition, the project was also asked to conduct an end to end review of the business operating model, in order to optimise sales, service and other processes (including claims) for best practice and Treating Customers Fairly and also review opportunities/feasibility for the Bank to develop its creditor offering in line with customer needs and best practices.

(iii) The project delivered on a number of fronts including, the strengthening of eligibility, sales scripts and sales processes, enhanced sales training, design and implementation of a suitability tool.

(iv) The Bank participated both bilaterally and through industry associations with regulatory bodies and other key external stakeholders. The Bank kept the regulator abreast of progress at key stages.

12. Details of when the bank became aware that PPI was being mis-sold, including details of any involvement of the Board and the control functions within the bank in discovering mis-selling.

(i) As highlighted in Question 1, the Bank took regulatory guidance from the FSA, as it evolved, to adapt its PPI sales processes. The following statements relate to problems identified with failings to deliver in line with Bank policy which were identified and escalated, and also where asked by the FSA to cease single premium PPI policy sales.

(ii) Bank Audit and Risk Committee—1 June 2005 (chaired by Graham Harold Stow). The Bank quarterly Internal Audit Report to 30 April 2005 was reviewed. It noted that: “Increased control over sales procedures for loan Repayment Insurance where older customers were involved were recommended…”

(iii) Bank Audit and Risk Committee—8 December 2008 (chaired by Graham Harold Stow). “The Chief Executive reported that Payment Protection Insurance (PPI) was moving up the risk agenda. The FSA had made an industry-wide request, including CFS [the Bank], that single premium PPI policies be withdrawn from sale no later than 31 January 2009. The FSA had indicated that it would issue a public statement on this in January. In addition, following the referral of PPI issues by the Financial Ombudsman Service to the FSA, there was an industry-wide process being undertaken which was likely to result in a new ‘super’ complaints process being agreed—this could also be publicised in January. Also, the Competition Commission was expected to announce its final decision in relation to PPI in January. The Chief Executive confirmed CFS’ intentions to agree to the FSA’s request to withdraw single premium PPI policies from sale in January. He also stated that strong representations would be made to the FSA about the likely undermining of public confidence in the banking sector by the combined effect of the actions detailed above and the consequent likelihood of a large increase in complaints, probably fuelled by complaints management companies using highly questionable tactics.”

(iv) Finally, and as referred to at paragraph xvii in Question 1 above, in May 2007 the Bank undertook a customer review to test whether its newly implemented assessment process would have delivered different customer outcomes for customers who had bought PPI under the previous sales processes. Of the 632 customers who responded, only 9 cases were identified as unsuitable and 4 ineligibility issues were identified, suggesting that there were no systematic failings in the Bank’s sales processes. These results, along with PPI penetration rates by channel that indicated that “no major shift in PPI penetration rates was experienced around Period 3” (March 2007 implementation date), were shared with the FSA in November 2007 and noted in FSA’s reply of 6 February 2008 (as referred to at paragraph xxiv in Question 1 above).

(v) The Bank’s approach has been that where we have identified a policy that should not have been sold, for example age ineligible customers, we have sought to remedy this through appropriate refunds and the introduction of enhanced controls.

13. A timeline of the action the bank took, both externally and internally, when it discovered that it was mis-selling PPI.

(i) A general timeline, relating to all actions taken by the Bank is articulated in the response to Question 1.

14. What sanctions, including clawback of remuneration, have you placed on any staff who were involved in mis-selling of PPI? Please indicate the level within the organisation at which these staff were working. Please also indicate whether or not the bank continues to employ them and, if not, whether they are working in an FSA controlled function at another regulated firm (according to the FSA’s register of approved persons).

(i) In response to the question raised on PPI the Bank Remuneration & Appointments Committee, (chaired by Rodney Baker-Bates) considering the 2011 bonus and 2009–2011 LTIP outturn considered the following:

1.Consideration whether any of the Bank Executive or Senior Management were “directly accountable” for the PPI mis-selling and benefited from profits related to the activity.

2.The 2011 annual bonus did not include any profits realised from PPI selling, which too was the case for the LTIP 2009–11 due to the cease in activity in Jan 2009. Profits pre 2009 would have included benefits realised from PPI activity however the Remuneration Code was not in existence and nor was clawback built into scheme design as was common within the Financial Services sector. The power to reclaim bonus is therefore unclear.

3.2011 AIP outturn was reduced by 10% and 2009–11 LTIP outturn reduced by 15% for the Bank Executives in light of PPI. The Remuneration & Appointments Committee did take the decision to discount awards due to reflect the impact of PPI on the financial performance of the business.

4.None of the Bank Executive or Senior Management were deemed directly accountable for PPI miss-selling or to have benefited from profits related to the activity.

(ii) Breach of Bank policy forms part of the performance management and disciplinary process and therefore can lead to sanction. Anecdotal evidence suggests some individuals below this level have been dismissed for not following Bank policy appropriately.

15. What discussions did the bank have with its External Auditors about PPI mis-selling and on what dates?

(i) A schedule of meetings between the Bank and its external auditors is attached in Appendix A. The topics for discussion, from KPMG records, were the subject of provisioning for PPI related claims.

(ii) These discussions commenced in November 2010, prior to the first provision for PPI related costs being raised in May 2011.

16. Why, in your opinion, did the market itself fail to correct the “mis-selling” of PPI?

(i) It is clear that the sales practices deployed by those firms selling PPI have differed significantly. The first Thematic Review led to two firms being fined by the FSA and all other firms being contacted to express concerns highlighting those areas of ICOB where improvements were needed.

(ii) The Bank addressed the concerns raised by the regulator and their guidance as it evolved and we can only assume that other firms took similar action.

(iii) The challenge faced by firms has been that of interpreting ICOB and understanding what is adequate and what is not. In the absence of clarity, firms have developed their own processes to ensure compliance with regulation. When the first Thematic Review highlighted perceived inadequacies in this interpretation, firms have sought clarity from the regulator in order to gain greater certainty that any investment made in process, procedure and control redesign would achieve the required end state.

(iv) Added to this has been the involvement of multiple regulatory bodies (the FSA, OFT and Competition Commission) and the timing and synchronization of theirs and the firms’ activities. This has led to both confusion and delays.

(v) The continuing challenge of principles/outcomes based regulation and how to test concepts, such as fairness, has only added to the difficulty in understanding what is adequate.

(vi) The evolving opinion of changing FSA personnel and its impact upon evolving requirements, eg oral disclosure, should also not be overlooked.

(vii) The result has been a process that has proved lengthy, complex, at times confusing and in the end unsuccessful, with the sale of single premium PPI stopping in entirety in 2009.

17. At what stages during the period your bank sold PPI did regulatory intervention cause the product to be reviewed? What was the substance of these reviews and what changes were implemented as a consequence of these reviews? With regard to the FSA report on PPI in 2005, what action was taken at all levels of the bank from the board downwards?

(i) The actions the Bank took in enhancing its approach to PPI selling over the period are detailed in the response to Question 1.

18. To what extent did regulatory interventions alter the way PPI was sold by your bank. Please summarise where any of these interventions may have given rise to a view within your bank that sales processes were for purpose.

(i) The actions the Bank took in enhancing its approach to PPI selling over the period are detailed in the responses to Question 1 and 16.

19. What was your Board and Executive Committee’s assessment of the root causes of PPI mis-selling at your bank. Please provide minutes of any discussions about root causes that took place at Board and Executive Committee.

(i) Please refer to the responses in Questions 1, 10 and 16.

20. What has the Bank done to address the root causes of PPI mis-selling? What has been done to prevent mis-selling happening in the future?

(i) The actions the Bank took in enhancing its approach to PPI selling over the period are detailed in the response to Question 1.

(ii) There have been a large number of initiatives to reduce the risk of mis-selling over recent years. Fundamental to this was the embedding of Treating Customers Fairly into the organisation which started to influence customer outcomes from early 2008 with the implementation of a Treating Customers Fairly governance structure and detailed MI reporting. This led to:

1.Greater emphasis on Treating Customers Fairly/conduct issues in first line product management and distribution roles.

2.Introduction of balanced scorecards and quality/compliance qualifiers or clawbacks on incentive schemes and most recently the removal of sales incentives schemes.

3.Increased first and second line monitoring and more rigorous training & competence regimes.

4.Introduction of New Product Development governance process in 2011, which ensures Board are aware of any new product developments.

21. PPI is a product that was cross-sold alongside another product. Please provide details of retail products you currently commonly cross-sell.

(i) The Bank no longer cross sells products in the manner applied to PPI ie bundled into the total cost of the loan. Cross sales are additional standalone products such as with mortgages where we offer home insurance, life insurance, critical illness insurance and long term income protection.

(ii) The Bank does identify if customers have any additional needs and, if customers have a need for a particular product, look to provide that product to them. This is done by undertaking a Customer Relationship Review, identifying customers’ aspirations and financial priorities, whilst looking to match them against the Bank’s product range.

(iii) As a UK clearing bank, we offer a full range of current accounts to the Bank’s customers, which we see as a fundamental relationship product and look to provide relevant banking products to the Bank’s customers such as mortgages, savings products, credit cards and personal loans.

(iv) For General Insurance products, both home and motor insurance policies offer options on the level of cover:

1.Home insurance options include—Buildings, Contents, Accidental Damage, Legal Expenses, Home Emergency and Personal Possessions.

2.Motor Insurance optional extras include—Breakdown Cover, Enhanced Courtesy Car, Extended Foreign Use, Motor Legal Expenses Cover and Protected No Claims.

22. Please explain the advantages of cross-selling and risks arising from cross-selling from both the bank’s standpoint and the customer’s. Describe how you mitigate against any risks arising from cross-selling.

(i) The Bank has adopted a Relationship Banking strategy designed to develop long and mutually beneficial relationships with its customers.

(ii) Core to this strategy is the provision of products and services that address customers’ needs and aspirations over the term of their relationship with the Bank. This includes interactions to make sure products continue to meet customer needs, the provision of additional products and services to meet new or changed needs, as well as communications to provide information to allow customers to review the on-going appropriateness of their arrangements.

(iii) Cross selling generally refers to the sale of multiple products at one time, though it can also capture subsequent activities too. The Bank is focussed on the former definition here.

(iv) For customers the merits of cross selling are:

1.Time/convenience—customers want speedy efficient and reliable service. By appropriately addressing certain sets of needs in a combined way the Bank can keep interview times to a minimum, and enable a rounded conversation to be completed in one go. For example, good money management would, we believe, justify a new first time buyer seriously considering a range of distinct but related needs, directly arising from their house purchase. These could include, home insurance, life insurance, contents insurance. Whilst all these arrangements can be dealt with on a stand alone basis, addressing them together can allow all needs to be considered, compared, prioritised and assessed. For certain products, such as insurance, enabling a rounded conversation to take place can help address risks. For example, that customers subsequently fail or forget to act, by not putting in place any suitable arrangements. This can be especially important where customers are perhaps less familiar with certain types of product, or less interested in giving focus to what they might perceive as less important—this is a consistent challenge with protection needs.

2.Secondary advantages here relate to the benefits of undertaking a single fact find process, going through a single set of fraud and other “know your customer” checks, and if required single credit searches.

3.Value—it is often possible to provide customers with better value for money/enhanced service options by combining products together. This arises because cross selling can reduce administration and set up costs for firms enabling keener pricing/service options, it can allow different credit decisioning to be delivered because of increased data/behavioural insights, and it can optimise Anti Money Laundering, Know Your Customer and other checks (processing costs) that need only be done once.

4.Customers can also benefit in the event of problems arising or complaints, by simply having to deal with one firm.

(v) The principle risks for consumers associated with cross selling relate to:

1.A lack of transparency—is it always clear to the customer why and when they are being offered opportunity to purchase more than one product/service? Do customers understand that products can be bought on a stand alone basis?

2.Pressurised selling—are customers unduly influenced by the person they are reviewing needs with, to purchase products and services they may not want or need?

3.Undoing arrangements—do customers understand fully how to terminate such arrangements, do customers perceive there to be exit barriers?

(vi) Treating Customers Fairly, a range of conduct of business rule books, FSA’s wider principles plus allied legislation seek to codify how firms should address these consumer risks. A clear and enduring challenge though is how to develop a range of communications media to interest, as well as encourage, customers to review what has been communicated to them, to proactively reassess their arrangements, say, annually, to seek assistance to readjust/amend products if circumstances change, and to know how to exit products/services if required. We believe more thought and innovation is needed in this area.

(vii) For the Bank, the primary benefit of cross selling centres on building long term relationships with customers. We find that actively engaged customers behave differently from those just wanting single product solutions. Through this engagement we are able often to offer better value for money as a result of lower costs, and/or stronger behavioural credit decisioning. We also see some differences in relation to levels of dormancy/for instance, to actively use risk based pricing techniques to reflect different default exposures.

23. Please provide details of products you currently commonly bundle together and whether or not you explicitly charge for that bundle.

(i) Packaged Current Accounts are the only examples of products currently bundled by the Bank.

(ii) There are 3 types of Packaged Current Account where we charge a monthly fee: Privilege (£9.50), Privilege Premier and smilemore (both £13).

(iii) These accounts all provide Travel Insurance, Mobile Phone Insurance, additional overdraft facilities and a selection of Gadget Insurance, Airport Lounge passes, or Credit Report Monitoring Service. Breakdown cover is available on Privilege Premier and smilemore.

24. Please explain the advantages of bundling and risks arising from bundling from both the bank’s standpoint and the customer’s. Describe how you mitigate against any risks arising from bundling.

(i) As stated previously, the Bank has adopted a Relationship Banking strategy designed to develop long and mutually beneficial relationships with its customers.

(ii) Core to this strategy is the provision of products and services that address customers’ needs and aspirations over the term of the relationship. The bundling of products into Packaged Current Accounts is a way of providing customers with a suite of products and services that are both relevant and attractively priced.

(iii) To a large degree many of the benefits and risks relating to bundling for both the customer and the Bank mirror those set out in answer to question 22. However, there are some additional points to note:

1.Bundled arrangements are generally only available on an all or nothing basis. It is important therefore to make sure customers have all the relevant information about the various elements of the bundle on offer, and so that they can consider whether they wish to proceed with a bundle due to the heightened value attaching to one element. Nonetheless, it is vital that the customer has all the information to hand to enable a proper consideration of this risk. Additionally, it is possible that a new customer may already have existing stand alone arrangements in place. Should a decision to proceed with a purchase be made, it is clearly important for the customer to be made aware of purchase even if some part of the bundle holds limited or no value for them. It may still be economic/appropriate for a customer to pay for the benefits provided so that the risk of duplicate provision can be assessed, and any duplicate policies be discontinued.

2.Inertia—for some customers the simplicity of having a bundled arrangement in place can provide peace of mind, and comfort that they will be covered, should anything go wrong. There is an obvious risk, therefore, that Packaged Current Account customers do not regularly review their arrangements to check that the bundle remains appropriate. Enabling customers easily to staircase up and down between products is a practical way to remove barriers, annual benefits statements can also help give customers the information they require to make informed choices.

3.Arrangements included within a bundle may not be directly comparable to stand alone alternatives, due to differences in economics, negative (or positive) selection risk variations, breadth of cover, excess levels in relation to claims and so on.

4.We are actively engaged in the discussions with the FSA with regard to Packaged Current Accounts and have responded to the FSA Consultation Paper CP12/17.

5.In the response we have highlighted the Bank’s belief that it is crucial that banks are able to provide customers with sufficient information so that they are able to make an informed decision about the product and the insurance policies it may contain, which in turn enables them to understand whether it meets their needs on an on going basis.

6.Overall the Bank are supportive of the changes in the Consultation Paper in the context of reducing potential consumer detriment; however we have reservations.

7.In terms of the overall Packaged Current Account strategy, CP12/17 has caused the Bank’s Board to review its proposition and its fit within its risk appetite. It is felt that more complex products, processes and servicing arrangements have, on occasion, led to poorer customer outcomes and we are concerned that the changes set out in CP12/17 may result in longer interview times, multiple appointments, multiple documents and lengthy on going communication requirements. Consequently, the Bank is actively reviewing its strategy in this regard.

25. Missing from the Request

26. If you have replaced PPI, please specify what replacement products you have put in place, how they work and all key decisions in relation to them that were made by senior level product development or product approval committees, Board committees and the main Board.

(i) No products have been launched to replace PPI sold by the Bank. Alternatives have been considered and reviewed with the FSA, but within the context of recent market conditions they have not been considered viable.

(ii) There would appear to be a growing number of customers in the market without adequate accident, sickness and unemployment cover. There is little sign of this situation changing in the near future.

2 January 2013

APPENDIX A

(SCHEDULE OF DISCUSSIONS BETWEEN THE BANK AND EXTERNAL AUDITORS—QUESTION 15)
DATE RANGE 24/11/10 TO 20/12/11

PPI RELATED COMMUNICATIONS WITH EXTERNAL AUDITORS

Note: KPMG Highlights Memos as listed below included PPI sections. These provided updates to the Audit Committee and covered KPMG’s approach and findings for audit of the PPI provision.

APPENDIX A CONTINUED

(SCHEDULE OF DISCUSSIONS BETWEEN THE BANK AND EXTERNAL AUDITORS—
QUESTION 15)
DATE RANGE 13/01/12 TO 22/11/12

PPI RELATED COMMUNICATIONS WITH EXTERNAL AUDITORS

Note: KPMG Highlights Memos as listed below included PPI sections. These provided updates to the Audit Committee and covered KPMG’s approach and findings for audit of the PPI provision.