Much has been written on Wells Fargo’s continuing compliance woes, including by this blog last year on its unauthorized retail account opening scandal. The most recent compliance issue involves the bank’s foreign exchange (forex) desk, where it is accused of overcharging mid-market corporate clients. To be sure, overcharging for forex transactions has resulted in multibillion dollar fines for other large banks. But Wells Fargo is a recidivist. The WSJ recently published a story about a potential enforcement action by the Office of the Comptroller of the Currency against the bank for allegedly charging auto borrowers for collision coverage they didn’t need and charging improper fees to extend interest-rate mortgage loan commitments. Concerning the OCC’s potential charges, the bank responded that it is making changes “across our risk management functions and line of business operations to rebuild the trust of our customers and team members.”
On their face there is not much similarity between the capital markets activities of Wells Fargo’s forex desk and consumer lending. But there is a common denominator when one parses the difference between noninterest, or fee, income, on the one hand, and interest income, on the other, in the banking business model. Focus on the phrase charging of fees in these cases – either adding illegitimate charges to a legitimate service or making illicit charges in the first place. Charging fees generates the noninterest income portion of a bank’s financial statement. In this respect, the fake retail accounts, which generated annual fees, interest charges, and overdraft-protection fees, were no different from the forex fees. It is no surprise that noninterest income has assumed significantly greater importance for banking institutions in this historically low interest rate environment. Such an environment limits the amount of yield banks can earn on loans and other long-term assets, which is the source of interest income. The Federal Reserve’s statistics, which reflect a historically low amount of interest income since 2010, bear out this industry dynamic.
As this blog also noted concerning Equifax’s hacking scandal, strategic business priorities logically flow from a company’s main profit-making lines of business. But a well-managed company will have a corporate governance system that achieves an appropriate balance of these business priorities against the need for management of compliance and reputational risk.
Wells Fargo’s spate of scandals shows that its board of directors has failed to establish such a balance, either through an ineffective risk monitoring system or establishing a skewed balance of these priorities. Instead, the bank appears to have relied disproportionately on incentive programs that make employees obsessively focused fee generators. The unauthorized account openings involved unrealistic daily account opening quotas. In the forex case, the bank awarded bonuses to forex traders solely on how much revenue they generated, the only major U.S. bank to do so. As the WSJ article notes, current and former employees on the forex desk said the bank’s pricing practices were rooted in a culture and compensation system that looked to maximize revenue. Bankers would earn 10% of a fee in excess of a target amount. These scandals involving fee revenue reflect problems that start at the top.