Roger McCormick: We can’t have big, unruly banks that are out of control

Ever-larger fines for bank misconduct have made headlines around the world, leading the London School of Economics and Political Science‘s Conduct Costs Project to estimate total costs between 2009 and 2013 for 10 major global banks at nearly £100 billion, plus a further £58 billion put aside in provisions at 2013-end. Roger McCormick of the LSE led the project, and he set up and now runs the CCP Research Foundation to build on its efforts. A former partner at law firm Freshfields Bruckhaus Deringer, he spoke with SNL Financial on the sidelines of the British Bankers’ Association annual conference in London about the purpose of fines.

This interview was published on the Conduct Costs Project Research Foundation website and has been republished here with permission and thanks.

By Christian Wuestner

SNL Financial: New U.K. regulations aim to increase accountability of senior managers at banks for failures, including introducing a new criminal offense. Is this a good idea?

Roger McCormick: I am pretty much on exactly the same ground as [Bank of England Governor] Mark Carney on that. I am sympathetic to the concerns it raises for people who are not used to the new regime, but you have to put it in context. Twenty-five years ago, there was a famous legal case in England called the Hammersmith and Fulham Case, sometimes called the Swaps Case, where a lot of banks entered into swaps contracts with English local authorities. The auditors of those authorities challenged the contracts, took it to the courts and won because the contracts were invalid. So the banks could not enforce those contracts. And they all complained to the Bank of England and other people: “We didn’t know about the legal risks involved in these contracts.”

And yet it’s common knowledge that the people who were doing the deals did know that there was a risk. There was even a legal opinion floating around warning them about the risk. But the senior management said: “We didn’t know.” Now if you fast-forward the situation to, say, the LIBOR scandal, then you have the senior management saying: “We didn’t know. It was other people. We didn’t know. It’s not our fault.” And you get it in all sorts of other scenarios, too. Money laundering problems, mis-selling problems — senior management always seem to say, “Oh we have no idea this was going on.”

Patience has run out and it’s no longer acceptable for them to just say, “It’s not our fault, we didn’t know.” Laws of this kind reflect that impatience. We’ve had enough of this. We can’t have big, unruly banks that are out of control with no one at the top really accepting responsibility for what’s going on. The response is perhaps quite harsh, but I understand it, and it will be interesting to see how it works in practice.

Subsequently, the management will have to make sure they know everything.

And if they can’t do that, they have to think about their business model because they can’t continue saying we are responsible for a business but we don’t know 20% of what’s going on. It’s just not tenable.

Bank fines for misconduct seem to be generally on the rise, especially in the U.S. What’s the driver for it?

It varies from country to country; they are not increasing everywhere. But to some extent it reflects the degree of exasperation from the public, whom the regulators in effect represent, over banks’ apparent inability to deal with the misconduct issues. Unless and until we can see a marked improvement in that, we just have to assume that the fines will remain at a high level, may even get higher, and they will be particularly severe for banks that show that they are in effect repeat offenders.

You suggested earlier during your presentation that fines are generally higher in the U.S. and often hard to explain. Can they be standardized at all?

It is hard to work out exactly what lies behind some of the figures, particularly in the U.S., because they are often the outcome of secret negotiations. The U.K. is a little bit more transparent; there is quite a lot of information in the final notices. Consistency, I think would be quite desirable, especially within the European Union, where there seems to be virtually no attempt to bring this within any kind of harmonization process, which I find rather odd given all the talk we hear about banking union. This seems to be a fairly central core area for the regulatory process, and yet there is really very little consistency in the EU countries.

Should regulators take into account the ability of the bank to absorb a fine when deciding on its size?

People do bear in mind the possibility that a very large fine might in effect kill a bank. I don’t think they simply ignore that. However, there is a danger of moral hazard being taken to an extreme degree. If, for the sake of argument we had a bank which behaves notoriously badly, and may even have been weakened by previous fines, it seems to me that the logic has got skewed if you therefore treat that bank in a very lenient way because you are frightened of bringing it down. Maybe it has reached the point where it does need to be closed down if it’s a serial offender.

But I don’t think that regulators are blind to the possible systemic consequences of some of these things. We saw that to some extent with BNP Paribas SA. The U.S. probably did levy a slightly lower fine than they might otherwise have done.

Can high fines prevent future misconduct?

They are bound to have an effect over time. They are a very strong disincentive. You are seeing shareholders, the public in general, potential investors take these issues very, very seriously now.

Should fines in Europe be raised to levels where they are in the U.S.?

All I would plead for is a greater degree of consistency across the E.U. countries.

You suggested that it was strange that banks such as JPMorgan Chase & Co. or Bank of America Corp. were punished for the misbehavior of banks that they acquired at the behest of the state. Do you think that they should not be liable for the units’ misconduct prior to acquisition?

I am not being quite as dogmatic as saying that they shouldn’t have to pay. What I am saying is that this is the question that the public are bound to ask in a scenario like that and we don’t seem to be getting satisfactory explanations. It’s hard to believe that the issue didn’t come up at the time of the discussions that led to the rescue. If there was a conscious decision by the bank purchasing the rescued entity that they would take the risk, then that’s fine, that’s fair enough. However, the rumors all suggest that wasn’t the case, and that they actually feel aggrieved that the fine was levied anyway. So the public is [wondering] what actually did go on? We don’t know the answer.