Read as updated SSRN paper with reference to the Panama Papers. Because of the Budget 2016, the chancellor has been accused of “looking more like Gordon Brown as a purveyor of gimmicks.” In difficult times when calls for his scalp over the row regarding the budget seemed to have eclipsed everything else, the rare bit of good news for George Osborne is that he can use the opportunity provided by the threat of Brexit – “a leap in the dark” which may cost the UK £100 billion or 5 per cent of GDP and 950,000 jobs by 2020 – to camouflage and obfuscate the real problems of conduct in the world of economics and finance. On the other hand, in an important interview with Charles Moore the former Bank of England governor Mervyn King showed hallmark signs of euroscepticism and said the people need to make up their own minds about the upcoming referendum. King also warned that lenders have not stopped taking excessive risks with savers’ money and the result is “bankers have not learnt the lessons of the Great Crash”. Unsurprisingly, in his somewhat controversial new book The End of Alchemy he makes the case against financial sorcery by arguing that it must be squeezed out of the world’s banking system. Perhaps, such failings are amplified further because “financial crises are a fact of life” and we are “moving into a rerun of the credit crunch”. Indeed, Lord King calls banks “the Achilles heel of capitalism.”
Below I sketch important/emerging issues in the intersecting themes of economics, law and misconduct as seen in the media, especially through the lens of “conduct costs” – some other themes are also explored. Mentioning Walter Bagehot and his classic text Lombard Street, which argued that the BoE should provide short-term financial support in times of crisis, King advises us that the old “lender of last resort” model (LOLR) is in need of revision because “banking has changed almost out of recognition since Bagehot’s time.” The former governor argues that the time has come to replace LOLR with the pawnbroker for all seasons (PFAS) system. For him, it is time for financial institutions to drop LOLR and embrace PFAS and be prepared to advance funds to just about anyone who has sufficient collateral. “The essential problem with the traditional LOLR,” argues King “is that in the presence of alchemy, the only way to provide sufficient liquidity in a crisis is to lend against bad collateral – at inadequate haircuts and low or zero penalty rates.”
By ensuring that the provision of liquidity insurance is mandatory and paid for in advance and by creating a system which taxes “the degree of alchemy in our financial system,” PFAS offers concrete advantages over LOLR. In times of “radical uncertainty”, argues Lord King, accurately predicting the future utility of actions is not an option and even in mounting a stern critique of his approach John Plender accepts that the former BoE governor’s new book is “dazzling” and “intellectually exhilarating.”
In other market analysis, David Kauders argues that generous money supply policies cannot cure the economic ills of our times. Giving the example of a boiling pan, he explains “enough steam can lift the pan for a while but it always snaps back into place when the steam runs out.” Kauders is adamant that the bull market (a market with many buyers) will be replaced by the bear market (a market with many sellers) and as he points out “markets move in great cycles and every bull market is followed by a bear market as surely as night follows day. Bear markets are a normal part of the capitalist system.” Notably, since the FTSE 100’s inception in 1984 there have been 12 “bear markets”.
Of course, the meltdown of the steel industry is not helping the government either. Distinguishing the troubled steel industry’s woes in Port Talbot from rescuing the too big to fail “umeritorious banks”, the indefatigable Charles Moore yet again explains with trademark precision “any group of businesses that is too big to fail can hold the country which it inhabits to ransom.” Elsewhere, it is said Barclays – Britain’s second largest lender – did not need to be bailed out during the financial crisis and has been continuously profitable with pre-tax profits of £6 billion in 2015, albeit investors and executives may feel that the bank has failed to squeeze every drop of profit out of the markets. For example the media (The Telegraph/The Financial Times) says Barclays, whose capital buffers are seen as weak, is a bank with “an identity crisis” despite its profitable Barclaycard business. Conduct related investigations remain outstanding against it and the bank has poor rapport with the regulators for past misdeeds.
Ring-fencing in the UK will not come cheap but the bank has opportunities in the US vis-à-vis Barclaycard’s expansion and creating leaner, more streamlined, investment banking operations. Despite axing its Africa division it is still a player on the international stage. Its new American boss is seen as a fresh strength. Jes Staley keeps stressing that the bank needs to focus on integrity to prove itself to the public.
A diametrically opposed picture of the bank can be seen through the 8 per cent plunge in share price, fines and stricter regulation to make the case that despite the “tremendous potential” attributed to it by Staley, Barclays is not the strong contender it is made out to be in other press reports. Interesting debate is sparked by controversial statements made by the bank’s chairman, John McFarlane, who has argued in the annual report that “outsized” fines for bad behaviour are causing a “societal cost”; provoking the bank to sell assets and undermining its support for the economy. Rightly or wrongly, he bemoans the £20 billion in potential profit that Barclays has lost out on as a consequence of fines and compensation.
But Andrew Tyrie, the Treasury Select Committee’s chairman, has retaliated by explaining the fines are for the greater good and “are needed because the conduct by the banks has been shocking.” Yet, echoing the zany and unapologetic style of the ex-chief executive Bob Diamond, McFarlane is adamant that “the societal cost of excessive penalties is very real.” For him, the £290 million LIBOR rigging penalty demonstrates that Barclays was singled out and made an example of. He cunningly relies on the BoE’s research which suggests that $150 billion in fines translates into $3 trillion of lost lending capacity. (Diamond, who left Barclays over its involvement in LIBOR rigging, has not lost the ability to sniff out a good deal. He has been eying and looks set to bid for the juicy bits of the bank’s African assets.)
Andrew Tyrie’s approach converges with the civil society position advocated by Professor Roger McCormick who argues for “serious retribution” and explains that responsibility must be accepted at a senior level because “pious expressions of regret” are insufficient redress for misconduct. (Like numerous high-powered publications, Lord King’s book mentions the CCPRF’s research.) Overall, it is difficult for bankers to complain of being singled out for disproportionate treatment because they are able to extract huge pay packages and perquisites despite the high level of misconduct – an inevitable consequence related to maximising personal gains – prevalent in their profession. Figures just released by the European Banking Authority show that nearly 3,000 City bankers took home more than £1 million in 2014, a jump of 40 per cent on the year before.
Moreover, as we know only too well through the recent analysis on high pay by the London School of Economics, despite epic levels of misconduct executive pay levels stand at stratospheric levels and on average CEOs of FTSE 100 companies, an awful lot of whom are considered “pretty mediocre” by headhunters, are annually receiving £4.6 million as remuneration. Things are so far gone that Antony Jenkins, who was fired from Barclays as CEO in 2015, will be paid £500,000 on top of his salary for rewards for failure despite being sacked. To many ordinary people, such levels of pay would be absurd even if the banking sector were free from vice. As for the chancellor himself, analysts argue that “his most egregious error is to define economic security wholly in terms of bookkeeping” and to add insult to injury they add that his economic policy suffers so badly from “fatal flaws” that “he would fail his economics GCSEs”.
Reading the money and investing pages in The Telegraph, it is quite mind-boggling to learn that Barclays is serially victimising its customers such as Daniel Head who can’t take credit, move banks or even secure a new mobile contract because the bank mistakenly put a fraud flag against his name and refused to remove it. “I paid a US cheque into my Barclays account – and became unbankable,” explains Head. Likewise, Charles Bartlett, a student, suffered a similar fate when Barclays closed down his account following his dealings in the digital currency – Bitcoin. “They still haven’t given me an actual reason for closing the account,” remonstrated the aspiring entrepreneur whose only cheap option would be to complain about Barclays to the Financial Ombudsman Service.
But then again there are those that Barclays is unable to oppress. For example, the bank was sued this January for £1 billion by PCP Capital, a private equity firm founded by Amanda Staveley. The claim concerns emergency £5.8 billion fundraising in 2008. PCP, which invested on behalf of Abu Dhabi’s Sheikh Mansour bin Zayed Al Nahyan, alleges that it was a potential investor and not just an adviser during the deal and therefore could have benefited from the capital raising. Barclays thinks that the claim is misconceived and plans on defending it.
Similarly, Wafic Saïd has sued Barclays for unexpectedly terminating a 40-year client relationship. Barclays gave him three months to seek out a new lender. The businessman and Tory party donor said he was not going “to be treated in this caviler manner”. The weird severance of ties with Saïd is a likely consequence of the £72 million fine imposed on Barclays in November 2015 for breaching the anti-money laundering rules.
The Saudi-Syrian businessman, worth £1.5 billion, is perhaps most famous for funding the Saïd Business School in Oxford University to which he has apparently given £70 million to date. He shot to fame in the 1980s for his involvement in negotiating the £43 billion military contract for fighter jets between BAE Systems plc and Saudi Arabia. The contact was investigated by the SFO but the investigation was dropped. Memorably, because the Saudis threatened to retaliate by withdrawing co-operation in counter-terrorism if the fraud watchdog’s probe continued, in R (Corner House Research & Anor) v Director, SFO  UKHL 60, Lord Bingham of Cornhill concluded at para 41 “the director was confronted by an ugly and obviously unwelcome threat” and was right to drop the case. “The BAE decision did enormous amounts of damage to our national reputation, no question about that,” is how the SFO’s present director David Green put it in his interview (10 April 2016) to The Sunday Telegraph.
Even though the FCA elected to drop the important review of culture, its outgoing chief Tracey McDermott shows no signs of giving up her tough talking ways. She says that regulators cannot stop fining the banks if the banks continue to misbehave: “The answer can’t be that we just stop penalising them,” she explains in her recent interview in The Sunday Times. She supports the Senior Managers Regime but worries that the banks will slip back into their old ways. Crediting herself and her former boss Martin Wheatley for singlehandedly reforming the sector, McDermott argues that “it would be very very easy to for change to be reversed … the concern is that banks will stop caring and begin to turn a blind eye to bad behaviour.” John McFarlane has applauded her for guiding Barclays through a nebulous web of regulation when tough times befell the bank. Small wonder that she is leaving the FCA for a better role in the financial sector.
But as everyone knows, the reality is that the banks have not become good citizens yet. Oddly enough, if you are a failing bank and need to be rescued, so as to avert economic disaster, the state will save you no questions asked. Yet if you are unemployed and struggling to find work, you will be expected to pull yourself up by your bootstraps. As seen in the connected post on benchmark rigging and criminal proceedings, the arrival of the SMR brings the promise of greater responsibility being placed on senior staff and time will tell whether or not the higher level of conduct enshrined in the SMR will make a material difference in the actual practice of banking? Whatever is added to better standards remains to be seen and the public can only hope that those in senior positions will make the regime their new bible.
“If all you do with painkillers is keep taking them but never deal with the underlying symptoms, you never get better,” explains Professor Lord King in absolutely unambiguous terms. Taking Lord King’s concerns together with the rosy compliance related picture painted above, it is noteworthy that HSBC, the UK’s largest lender, has a five-year deferred prosecution agreement (see here) with the Department of Justice for failings in connection to drug cartels and money laundering and was fined £1.4 billion in 2012. However, its latest annual report explains that it has failed to satisfy the DoJ’s demands. Standard Chartered, Barclays, Credit Suisse and Lloyds also have DPAs in America and the first DPA in the UK was seen in the case of Serious Fraud Office v Standard Bank, a case also involving the first use of the offence of failing to prevent bribery – under section 7 of the Bribery Act – since its introduction in 2010.
The corporate sector has a poor reputation but Mark Carney strangely declared last year at Mansion House that “the Age of Irresponsibility is over”. However, with each passing day new scams cutting across the entire spectrum of financial services keep emerging and the mantra could not be further removed from reality. The authorities keep trying to bottle earlier scandals but new ones constantly keep arising making it impossible for regulators, and even courts, to remedy all the awful things that go on behind the scenes. The public only comes to know about things very late in the day and the banks prey on the public’s ignorance to fill their pockets. So using mystique to cast the impression that all will be well in the future is a hard thing to achieve in the long run.
Yet appeasing the banks still seems to be quite high on the Treasury’s agenda. For example, Sir John Vickers, who chaired the important Independent Commission on Banking, has criticised the BoE for not taking on board his concerns about “additional capital requirements that domestic banks of systemic banks must have”; the ICB proposed an additional buffer over and above the baseline of 8.5 per cent laid down by the Basel III regulation. However, Vickers is disgruntled because the BoE preferred to keep the extra equity buffer at 0.5 per cent rather than the 3 per cent of risk-weighted assets, a construct used by regulators to ascertain capital requirements.
The suffering of consumers keeps expanding. Common people suffer the most and confidence in the corporate world, which just tries to extract every drop of profit out of the market, is seriously undermined. For example, Payment Protection Insurance mis-selling and cheating on taxes are just some examples of bank misconduct. Taking the case of PPI mis-selling, it is the case that complaints connected to the scandal amount to 56 per cent of all the Financial Ombudsman Service’s workload. The scale of the problem is big – for example, PPI has cost Lloyds Banking Group a total of £16 billion in provisions. The FCA is considering imposing a 2018 deadline on claims and the banks are spending tens of millions of pounds on advertising in order to create awareness among consumers so that they can seek redress accordingly.
For each hole that regulators and banks try to plug up, ten new ones open up and they are running out of fingers to stop the flood of problems from breaching their defences. Closing the door on PPI claims to appease the banks is not exactly what the Supreme Court had in mind in Plevin v Paragon Personal Finance Ltd  UKSC 61 where Lord Sumption, who is not known to mince his words, found the non-disclosure of the commissions payable out of the borrower’s PPI premium made her relationship with the lender unfair.
His Lordship therefore reasoned that at some point commissions might become so large that the relationship could not be regarded as fair if the customer were kept in ignorance. Though it was hard to pinpoint with precision, but wherever the tipping point might lie, the commissions paid in most cases were a long way beyond it. The responsibility for disclosure lay with the lender, which alone had been aware of the size of commission payable to both itself and the broker. So the kickbacks were illicit and strongly represented a deficit of trust.
Statistics released by the FCA just the other day show that complaints about PPI increased 6 per cent in the second half of 2015 (932,298 complaints) and made up almost half of all complaints against banks. But overall complaints were down 1.4 per cent because of fewer complaints about current and savings accounts. Barclays was the worst offender with 279,561 complaints, followed by Lloyds Bank (230,041 complaints), Bank of Scotland (182,702 complaints), Natwest (135,262 complaints) and HSBC ranked last (with 120,986 complaints). However, according to the FCA, complaints against all these banks have declined in comparison to past periods.
The CCP Research Foundation’s research shows Barclays spent £12.2 billion on misconduct between 2010 and 2014 in regulatory fines and litigation. Other research conducted by Corlytics, an analytics firm, also shows that the world’s top ten investment banks (i.e. Barclays, Bank of America, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, JPMorgan, Morgan Stanley and UBS) have paid $150 billion in fines between 2009-2015 and failures in customer reporting (amounting to $43 million in fines) are said to be the most egregious heads of misconduct for these big banks. Equally, as reported, investment banking in Europe is shrinking because of market turmoil and restructuring in such poor markets in proving tedious. The research shows that seven years of fines have seen the equivalent of 14 per cent of their equity capital being wiped out. As reflected in the figure of $27.7 billion, fines for selling residential securities came in second. Other figures include $20.2 billion for securitisation failures and $14.6 billion for “rate setting” fines arising out of forex manipulation.
However, in fact things are much worse. In their recent lecture titled The Cost of Trust Gone Wrong – $300 Billion and Counting where issues related to the ‘rebuilding of trust agenda’ are highlighted, Roger McCormick and Chris Stears pointed out to members of the Chartered Institute for Securities and Investment that until 2012 recklessness and negligence used to be associated as banks’ conduct related failings rather than cheating, lying and fraud. As argued in the lecture, it was known for years that PPI “stinks” but the bigwigs in banks such as RBS felt “we can’t be the first to stop”; in other words, “we don’t care”. Under the umbrella of the CCPRF, Roger (managing director) and Chris (research director) are the pioneers of an expanding new social movement that seeks to convert ideas and research into high level analysis aimed at creating public awareness about how to improve ethical failings in financial services.
I think that Roger and Chris would agree with me that the chancellor’s Faustian pact with Dr Carney may not be working and will probably not save galaxy UK from another major economic meltdown if one decided to come along tomorrow …
In reality, in order to conceal the low-point in public confidence, empty rhetoric and hollow buzzwords such as “social licence” and “real markets” reign supreme while regulatory spin seeks to reconstruct the common person’s trust in the system. For economists Adamti and Hellwig “willful blindness helps bankers and policymakers to overlook and ignore risks they take and to deflect criticism.” They argue that deliberate supervisory blindness is the product of collaboration between politicians and regulators.
Just to address the PPI problem in a bit more depth, notably £44 billion worth of policies were sold between 1990 and 2010. Not all of them were mis-sold but the FCA reports that £23 billion has been paid out for PPI mis-selling since 2011 and almost half of redress payments (or £11.5 billion) relate to interest and not premiums. Apparently banks may pay another £22 billion for PPI claims. The chairman of the Professional Financial Claims Association, Nick Baxter, estimates that 75 per cent of PPI policies were mis-sold. Banks have reportedly set aside £32 billion for redress of which £23 billion has been paid out which means that £22 billion, estimated by the PFCA, which remains to be paid is not covered under existing redress arrangements. The FOS finds that banks are wrongly refusing redress to consumers and out of the 141,000 complaints submitted between April and December 2015 it upheld 70 percent of them in consumers’ favour. However, some like James Daley of Fairer Finance argue that they would not be surprised “if there were billions of pounds left unpaid.”
Basic failures in banking are not being properly addressed but tech in banking is going from strength to strength. Even the metropolitan police commissioner, Sir Bernard Hogan Howe, has irritated victims of fraud by arguing that they and not the banks should be liable for connected losses. The top policeman is afraid automatic refunds reward negligent and bad consumer behaviour. Yet as disclosed by the money pages in The Sunday Times, the banking giant Barclays has been forced to pay £55,000 to “negligent” fraud victims “Mr and Mrs H” whose personal details were divulged by bank staff to conmen over the phone who were easily able to breach the bank’s lightweight security arrangements. Commenting on the case, the Financial Ombudsman Service explained “banks can duped just like consumers” because criminals are able to create “increasingly sophisticated” scams to defraud people. In her article, Barclays forced to pay fraud victims £55,000 Anna Mikhailova reports: “The ombudsman said the bank gave out details that helped conmen to steal from a couple”.
Despite internet service failures seen over the last year, high tech banking is not in short supply and banks such as HSBC, which has decided to keep its headquarters in the UK after reportedly taking £40 million worth of advice, are trying to woo customers by the watertight security offered by the prospects of operating a system of biometric authentication. HSBC is the UK’s largest lender and its innovation head, Cristophe Chazot, contends that the “approach to innovation is embracing it in a way that is secure … and unique … we have developed our own methodology to approach this.” Chazot claims innovation allows the bank to “roll out products more quickly”; it still has “a duty of care to fulfil,” he says.
“Fintech” (or financial technology), a virtually unknown term just a few years ago, is a major feature of the financial services industry which is said to annually contribute as much as £160 billion to GDP. HSBC is credited as offering “the most cutting-edge tech on offer from the big banks” and is also using biometrics for customer authentication. British financial technology is credited with generating £20 billion in 2014 and fintech is important to ensuring that the UK remains a world leader in banking, we can only hope that the banks do not sacrifice everyday integrity and values by trying to replace them with flashiness and gimmickry.
For example, we can only hope that they fare better than the Home Office – which also uses biometrics in immigration matters but still is one of the most inefficient departments in the country. It is also true that the banks are not conducting the checks introduced by the Immigration Act 2014 in relation to bank accounts and disqualified persons. All they do is ask whether the applicant has a visa? If you answer yes, they tend to believe you without conducting any checks.
But demand for online banking has never been higher. HSBC is using Link Screen to help businesses searching for an overdraft, loan or credit card to seek advice in cyberspace rather than visiting a smelly branch. Lloyds has been conducting mortgage interviews from customers’ homes and offices via video link. Branch visits are falling and mobile app logins have reached record numbers (895 million in 2015 expected to rise to 2.3 billion by 2020, as estimated by CACI). However, according to Financial Fraud Action UK, online banking fraud was up by an eye-watering 48 per cent between 2013-2014.
A study by Citigroup explains that US and European banks will axe 1.7 million jobs over the next ten years because of fintech. (According to its 2015 annual figures, last year Citi Bank held $301 billion in deposits, and had $391 billion in average assets including $281.3 billion in average loans.) This represents a 30 per cent decrease in staff presently employed by banks. The study finds that US investment banks have cut jobs more than consumer banks and, as one would expect, the changes are more deeply rooted in tech savvy countries and cultures. As widely reported, Santander is planning to close 450 branches in Spain because it wants to drive up its profits by taking advantage of the opportunities provided by digital banking. A thousand jobs may be lost because of the cost-cutting move, which represents a 13 per cent cull in the bank’s 3,467 branches.
Co-operative bank’s CEO Niall Booker’s £3.85 million pay package, up from £3.1 million on the year before, is another case in point on the issue of high pay. Because of its small size, many people may think that Co-op bank must be a “good” or “ethical” bank. When bondholders took over the bank, the Co-operative group became a minority shareholder (20 per cent). It was saved from collapse in 2013 by hedge funds after it emerged it suffered from a £1.5 billion capital shortfall or “black hole”.
However, Co-op bank, which was recently restructured to shake off such anomalies, has just recorded a loss of £610 million (compared to £264 million in 2014) and blames the costs of misconduct for its predicament. It suffers from a legacy of PPI mis-selling and its conduct charges for 2015 soared from £92.5 million to £193.7 million. Its overpaid CEO, who looks set to depart after being extraordinarily rewarded, has said that the bank would continue to post losses for another two years – which, of course, is telling about its faltering rehabilitation. Its reputational losses are made all the more severe by revelations of Class A drug use by its former chairman Paul Flowers.
The case of HSBC is intensely hypocritical. For example, in 2008, addressing the dilemmas of corporate social responsibility, Lord Stephen Green, then group chairman of HSBC Holdings plc, subsequently minister for trade and investment (2011-2013), said: “Like many companies, we at HSBC, are on a long journey to becoming more sustainable” because “corporate social responsibility impacts organisational culture” – quoted in McCormick, Legal Risk in the Financial Markets, Second Edition, Oxford University Press, 2010, page 185.
So it is very surprising that we should learn through the Mossack Fonseca (see full discussion in my paper) saga that the Makhloufs, who are Bashar al-Assad’s family members with a pre-war fortune of £5 billion should be warmly received by the bank. “Rami Makhlouf was able to keep accounts open for months thanks to HSBC lobbying,” it has been widely reported.
Serviced by Mossack Fonseca, the world’s fourth-largest offshore company provider, Makhlouf was able to keep his Swiss bank accounts open despite the civil war. Though the US sanctions on Makhlouf were not binding on the Panamanian firm, “in January 2011 it rejected the advice of its own compliance team to cut ties with the family as the crisis in Syria began to unfold”. As revealed by the media, HSBC was against severing ties with the Makhloufs and “a February 2011 email from Mossack Fonseca’s Geneva office states: Mr [X] told me that HSBC compliance department of the bank not only in Geneva but also in their head quarters in London know about Mr. makhlouf [sic] and that they are comfortable with him.”
The International Consortium of Investigative Journalists has reported that apart from HSBC other banks acting in concert with Mossack Fonseca to service thousands of shell companies include Coutts, Credit Suisse, Rothschild and UBS.
As the ICIJ explains major global banks acted in concert with other players to help super-rich elites, politicians and criminals keep their assets hidden away in secrecy. The article informs us that out of nearly 15,600 registered shell companies created with the connivance of some 500 banks:
The British banking giant HSBC and its subsidiaries alone account for more than 2,300 of the companies, and UBS accounts for more than 1,100. Other big banks doing business with Mossack Fonseca included Société Générale (979 companies), the Royal Bank of Canada (378), Commerzbank (92), and Credit Suisse (1,105).
No doubt, the fine details of such affairs will continue to haunt politicians, regulators and banks alike for the foreseeable future. It will be interesting to see how fast the wheels of justice turn?