Insight : Reforming wealth management (Part 1 of 2)

The Jakarta Post, Amol Titus, Sat, 05/14/2011

Wealth multiplication is an ingrained motive in the capitalist model which sits at the heart of modern financial markets. And acts of entrepreneurship which result in legitimate wealth multiplication are to be marveled as lessons in good management.

For example, take the profits e-Bay has made on Skype. Some time ago it sold a 70 percent stake in Skype for approximately US$2 billion and earlier this week it will make a similar amount for its balance 30 percent stake sale after it was announced that Microsoft is buying Skype for a whopping $8.5 billion as it tries to keep up with the mega trend of web and device based social connectivity.

Many other examples abound and several Indonesian businessmen have similarly multiplied their wealth through shrewd investment decisions and impressive risk taking over the past decade.

However, illegitimate wealth multiplication through money laundering, fraud, tax evasion and corruption is downright illegal and deserving of criminal prosecution as per regulations.

Like any other criminal activity those accessory to it are also liable for prosecution under the law, both local and international.

As the recent serious fallouts from bank scandals have highlighted there is a seamier side of wealth management that is tarnishing the discipline and reputation of the banking system.

Worse it is obstructing the efforts of anticorruption teams whose hands must be strengthened if a key emerging market like Indonesia is to graduate beyond short term hype as a resource rich play to long term progress as a better governed economy.

To understand the seamier aspects of wealth management begin by asking four questions.

First, is it a core KPI of the seller of financial products to conduct proper due diligence on source of funds.

Second, is it the obligation (both professional and moral) of an overseas branch office of that institution located in a financial tax haven to distinguish legitimate wealth flows from illegitimate flows and stop hiding behind the hypocrisy of “the corruption did not occur in our country so it’s OK so long as funds flowed through some banking channel”.

Third, should the current bonus system of wealth managers which incentivizes leveraged sales of speculative products be reviewed and strictly monitored.

And fourth, should banks stop treating senior wealth managers as untouchable prima donnas and use common sense policies of rotation, codes of conduct and conflict of interest mechanisms.

If you believe the answer to the above four questions is ‘Yes’ then read on as the above issues and practical solutions will be elaborated in this two part series.

Bankers are prone to use the terminology of “smell test” to identify something fishy or suspicious related to banking transactions.

This is good because funds flows through banks are under serious scrutiny by regulators since serious crime invariably has a financial motive and trail.

In practical terms the smell test boils down to due diligence and surprisingly for a discipline as sensitive and prone to manipulation as wealth management, due diligence has tended to get lax and loose.

The main reason for this is that retail banking divisions of most banks now have two principal drivers of revenue and profitability — wealth management and consumer finance.

The wealth management product range has also become more complex as financial derivatives are now increasingly being sold to retail customers.

As margins reduce in sales to sophisticated institutional and corporate clients, treasury departments (the financial engineering labs within banks) are collaborating more with wealth management departments.

But problems arise when unsophisticated customers — individuals and SME business owners — are sold complex products at times with misleading sales pitches that over emphasize gains and downplay the risks which are very real and can come back to painfully bite the clients.

Since most banks have jumped onto the wealth management bandwagon competition is intense and as has been seen with other banking disciplines like credit cards or sub-prime mortgages when a ‘herd’ mentality is adopted standards invariably slip.

What has slipped the most is the quality and effectiveness of due diligence when a customer wants to open a significant wealth management account or make a sizeable transfer.

It is surprising that the same bank which will insist on salary statements, proof of income and assets for a simple credit card will not raise the alarm bell when an account holder is effecting a deposit or transfer that bears little co-relation to his or her salary or sources of income.

Asking for a NPWP (tax) number, sighting the account number of another bank or simply believing the customer under pressure or charm (majority of wealth management meetings take place in luxurious settings in which wealthy clients show off to gullible relationship officers) is incomplete due diligence.

Like with other aspects of banking there need to be firm procedures and systems to differentiate between genuine customers and those which require deeper background checks.

Once illegitimate funds enter the banking system chances of effective laundering are high and the seamier side of wealth management has also enabled conduits to seemingly untraceable tax havens, trusts, front companies and so on.

Reputable global and local financial institutions cannot talk of Good Corporate Governance and then turn a blind eye to the seamier aspects of wealth management practice.

Reform must begin first at home. The price of financial penalties, criminal liability and worse reputation damage is far too high to compromise.

International banks that have large wealth management centers in financial tax havens must also ensure that they have additional screens to detect illegitimate wealth and implement a cast iron policy that they will not become facilitators, wittingly or unwittingly, of corruption related money flows.

The columnist is CEO of international management consulting firm IndonesiaWISE. Prior to become a senior strategy advisor to leading companies and institutions, he spent over 18 years in the international financial sector. The second part of this article will appear in the next edition of Insight.