ANALYSIS: A policy of sytematic overcharging would not merely be delinquent but tantamount to commercial suicide, writes Ray Kinsella

It's called "operational risk". It means any failure in systems or protocol that subvert the effectiveness of a bank's operations, including those that underpin customer relationships and the value of the banks brand. More specifically, it involves ending up on the financial or, even worse, the news pages for all the wrong reasons.

It may be small comfort to AIB customers who have been overcharged to know that they have been the victims of a systems failure as opposed to being simply overcharged as a matter of commercial practice. However, the distinction is important in terms of organisational integrity as compared with effectiveness - and in identifying how best to protect customers against any repetition.

Banks, globally, have long operated in an environment which is obsessed with maximising shareholder value.

The short-term focus of this - impelled by the behaviour of institutional investors - has been largely responsible for the seismic cracks which have appeared in major corporate entities, notably in the US.

This has created a culture that generates pressure right throughout the organisation and is fixated on "maximising its share of the wallet". Because more than 40 percent (and rising) of bank income is generated by fees and commissions (non-interest income), it is little wonder that charges have become a highly sensitive issue.

Maximising fee-based income is pushed at every division, at every level and in pretty well every bank. The problem is that there is a tension between this objective and that of cultivating a "high-trust" customer relationship.

The more competitive the environment the more difficult it is to get this balance right. AIB, like other banks, has invested hugely in CRM (customer relationship management), and marketing strategies based on customer relationships. A systems error in this area is seriously bad for both the bank and the customer.

If competitive pressures are important then so too is the greatly increased compliance burden - both statutory and non-statutory - on all financial institutions. Consumer protection is at the heart of compliance.

The Irish Financial Services Regulatory Authority (IFSRA), which was established only two years ago, has already developed a highly pro-active expert capability which is now scrutinising this overcharging episode.

A policy of systematic overcharging involving non-compliance with established fee notification protocol would have been not merely delinquent but tantamount to commercial suicide.

It would run wholly counter to an ethos of "good citizenship" and "corporate social responsibility", which is where all banks are seeking to position themselves. The prospective damage, in terms of reputation and brand management, would be simply out of all proportion to any increase in fee income.

This leaves a systems failure as the probable cause of the over-charging. The difficulty that banks have in addressing this is the "Oh yeah?" syndrome, which is a product of an essentially adversarial relationship that has been allowed to develop across the financial services spectrum.

Banks are spending tonnes of money to counteract this and the last thing that they (and, even more importantly, their customers) need is such investment being wasted by systems failures.

Currently all financial institutions are busy implementing Basle II, which, amongst other things, involves allocating capital against prospective market risk, including a failure in operational effectiveness.

It must be a concern for regulatory authorities and bank management that an error can be embedded within a bank's systems for an extended period without being identified.

The error happened to relate to bank charges on a relatively small subset of its transaction with customers. It could, in principle, just as easily have related to the banking and capital markets side of its business. We have, over the past year, seen failings in the control systems of global banks, such as National Australia Bank and even Goldman Sachs.

One problem here is that internal controls tend to lag behind commercial practice, although this should not be the case. Potential problems should be identified by human expertise, and/or diagnostic software.

These kinds of problems can never be wholly eliminated. The issue is reducing the scope for, and probability of, such failures.

In this regard, it is surprising that banks are so narrowly focused in their systems testing, overlooking approaches that have a great deal to offer in terms of reducing the probability of such a failure.

AIB will have learned from the effectiveness of its response to the Allfirst debacle that credibility hinges on a pro-active and transparent response. Restitution, a core concern for the IFSRA, can be taken as read.

And, indeed, the IFSRA's response to this failure in consumer protection systems will have boosted the confidence of consumers that their interests are being safeguarded.

In retrospect, the real lesson of this, and failings in other multi-national banks, may be that the internal controls systems are simply not sufficient

Prof Ray Kinsella, of the UCD Smurfit Graduate School of Business, is editor of Internal Controls in Banking