By Ismail Erturk, expert in banking at Manchester Business School
Ever since Bob Diamond, the star investment banker in the City and ex-CEO of Barclays, resigned in the aftermath of Libor fixing scandal in 2012 the pendulum of power started to swing in favour of the regulators in the City.
Prior to the Libor fixing scandal the bankers had wanted to turn a leaf over their failures that caused the costly banking crisis of 2008 that the economy in the UK has still not recovered from. RBS is still about 80 per cent state-owned, the flow of credit to SMEs has not meaningfully resumed as the recent Treasury Select Committee report pointed out, and the financial markets still need the Bank of England’s £375 billion quantitative easing to operate as normal. Jobs created in the UK are fragile in both duration and pay levels. The government still has a big deficit to finance.
Therefore when the new revelations regarding bank misbehaviour like manipulating interest and foreign exchange rates, mis-selling payment protection insurance to retail customers and interest rate derivatives to SMEs, money laundering, helping rich clients to evade tax etc. have gradually come out senior bankers ran out of excuses in explaining their misbehaviour.
No other industry would be able to survive such morally indefensible and economically costly behaviour without some top managers facing individual criminal charges and even some companies going out of business. However banking did survive these scandals because in the UK financial services and London have irreplaceable role both in the economy and in international relations.
Global money circulates through London since the 1960s to avoid national regulations and problems in international politics. This offshore nature of London coupled with political and legal stability give the UK clout in international economics and politics that the size of the UK economy itself can not provide. Therefore the country has always been openly or implicitly light touch on bank regulation.
However, as the banking scandals involving international banks based in London and domestic British banks have snowballed since the 2008 crisis the cost in reputation of the City to the UK has become a serious issue. When British-headquartered banks and international banks based in London were fined by regulators in the US the UK regulators could not remain silent. After all London is not just some offshore City State on some small island away from the rule and law-based world. It is in the centre of Europe where moral reputation and civilised behaviour have value. Especially when the banks in London are fined by the regulators of the biggest economic and political power in the world, the US, for money laundering.
We need to see the Bank of England’s recent tough stance on banks and the City in this context. Reputation can not be bought and has to be restored in the long-term interest of London and the UK. But also the society wants bankers to be treated just like anybody else and to be punished if they break the rules and the law.
This creates an important problem for especially non-executives on the board of the banks. Clearly non-executives do not have enough information about all activities of large banking conglomorates. Therefore they run the risk of being punished when they have no clue about what is going on in the bank that they are a director of. Would they then decline to accept such positions and the banks will not be able to fill the non-executive director positions on the board that the corporate governance rules require? And would senior managers in banking leave the banking sector and look for jobs in other industries or in unregulated shadow banking?
One senses a hint of threat by the financial elite to the regulators that banking will go into chaos because senior managers and board directors would flee banking if the Bank of England introduces regulation to hold individuals responsible for bank misbehaviour. I disagree with this prediction. Hedge funds and investment bankers did not flee London when financial regulation and bonuses were tightened after the crisis and I do not think that commercial bankers and directors will flee London either if criminal charges for individuals in banking are introduced.
The Bank of England is right to hold individuals responsible because almost all misbehaviour in banking was systematic and cultural rather than being the result of one or two lone employees breaking the rules. The culture of delivering unrealistic profits to keep share price and bonuses high incentivises individuals in banking to act in self-interest rather than in the interest of their customers. In investment banking there was a period when managers fired individual traders for being too successful because senior managers could not figure out how these individual traders could outperform their colleagues who had access to the same information set and trading models. Therefore the top management can instil a culture in banking where inexplicable abnormal profits are not tolerated.
Such banking organisations can be built. Regulators have to do their own job better too. Regulators have to pay much better salaries to employ best graduates and also develop a secondment system where bankers and regulators swap jobs regularly for short period of times so that regulators are not out of touch with the innovation and changes in organisational structures in banking. But more importantly large financial conglomerates should be broken up and new simpler but economically more efficient specialist banks in different types of retail and investment banking need to be created.
In large complex financial institutions there is bound to be informational asymmetries between individual activities and top management regardless of sophisticated management information systems and compliance mechanisms. Instilling a homogeneous culture in large complex financial institutions is almost impossible. Risk taking in investment banking cannot coexist culturally with conservatism in deposit taking activities. Bankers are to a certain extent right when they say the regulators cannot find senior managers and directors to run the banks if the regulators hold such senior people individually responsible for misbehaviour. But the bank managers and directors should be honest about their knowledge and control limitations at such large complex financial institutions.
It is in the interest of bank managers and directors to lobby for simpler banking. Some banks have already started to move in that direction like we have seen at Credit Suisse recently with the appointment of Tidjane Thiam as CEO that signals for a change towards simplicity in business model.