Conduct Costs on the Rise (2012-2016): No End in Sight

25 08 2017

The latest findings on misconduct in financial services reveal an upward trend in conduct costs. During the five-year period 2012-2016, the world’s 20 leading banks have paid £264bn for bad behaviour. This represents an increase of 32pc on the period 2008-12. A worrying aspect of adverse bank behaviour is reflected in the uninhibited expansion of conduct cost provisioning. The key question, explains Chris Stears, relates to the average level at which these costs will settle. “We find ourselves wondering when, if ever, the level of conduct costs will start to decrease,” is how Roger McCormick puts it five years after publishing the first league table for international bank fines. These concerns can only be magnified by new developments such as the Royal Bank of Scotland’s recent $5.5bn settlement with the Federal Housing Finance Agency to resolve toxic mortgage claims in relation to the lender’s issuance and underwriting of approximately $32bn of residential mortgage-backed securities in America. Equally, the fact that the US Federal Deposit Insurance Corporation is suing major British banks for $400bn cannot possibly alleviate people’s worries or instil confidence in banking institutions. Brought on behalf of 39 rescued American banks, the US government’s claim in London relates to LIBOR “lowballing” and the defendants include household names such as such as Barclays, Lloyds Banking Group and Royal Bank of Scotland. Even partial success in a claim of this nature could radically enhance the present level of conduct costs.

But still all this is only the gentle way in punishment. Conversely, the Qatari crisis that has hit Barclays may well trigger the beginning of the end for high-powered management personnel who have thus far generally enjoyed immunity from criminal justice. Ongoing fraud investigations against Barclays and John Varley (former CEO), Roger Jenkins (former Executive Chairman) and Richard Boath (former European Head) must have sent shockwaves through out the banking industry. The trio’s trial will undoubtedly be a closely watched and studied event and if they are convicted the game-changing Qatari fiasco shall define things for future times. The US authorities have also charged two managers from Société Générale, for participation in a scheme to rig US dollar LIBOR. Danielle Sindzingre and Muriel Bescond boosted Société Générale’s creditworthiness by submitting false information in relation to the rates at which the bank would be able to borrow money. As we already know the “numbers tell a story” and since the risks are very great “in the case of bank behaviour, they speak louder than words, and they tell a big, and scandalous, story.”

Overall, issues of public trust and accountability remain at the heart of the conduct costs debate. But these issues are often sidelined purely because economic decisions are made in glamorous places far removed from the harsh realities dogging the public. The public has a tendency to feed off the excesses of human rights law and foreign criminals and themes related to the political fall out of Brexit. The paradox, of course, is that everyone has something to do with money and we all need housing. So sustainable finance is a very important necessity for human survival. Unfortunately, however, society seems to be consumed by its own prejudices. This means that misconduct in banks tends not to get noticed despite the fact that it is something that affects almost everyone. Money is indivisible from people and the banks are indivisible from savers’ money and so the need for accountability, transparency and consumer satisfactions is very great indeed.

Tellingly, the big picture shows an alarming trend in the expansion of conduct costs. As shown by the CCPRF’s latest research, in reality, despite room for “cautious optimism”, there is no room to say that banks have finally overcome their historic failings and have vowed to stop misbehaving in a reckless way. It is far better to learn lessons from the past rather than simply let history repeat itself. As argued in the past, the CCPRF’s league table interacts with consumers of banking services by keeping them attuned to the nature of things in the banking sector. Just as the public has the right to know about crimes committed by foreign nationals on British soil and whether this country can even deport them, there is a pressing need to inform the public of the mechanics of corporate behaviour and responsibility in problematic economic times and uncertainty. Just like the terrorist attacks of ISIS inspired British jihadis and the hatred stirred up by right wing fascists must be stopped, the opulent world of finance where people are rewarded for failure must also be cleaned up. Yet the potential for corporate misconduct getting swept under the carpet is all too apparent.

RBS and Lloyds, two of Britain’s leading banks, find themselves in the top five offenders. During the period 2012-2016, Lloyds ranks in fifth place with conduct costs of £20.47bn and RBS is in fourth place with conduct costs of £21.51bn. The top three spots belong to US banks. Bank of America ranks first with £45.59bn, JPMorgan Chase comes in second place with a bill of £33.64bn and Morgan Stanley is in third place with a total conduct costs bill of £24.36bn.

Long run change cannot be cosmetic and, as the CCPRF’s research shows, there is a world of difference between falling levels of FCA penalties and the larger picture, which, of course, seems to entail further gloom and doom. Here are some of the points that Chris Stears, Roger McCormick and Tania Duarte have made regarding the CCPRF’s latest findings.

(i) Roger McCormick (Managing Director CCPRF)

  • This year’s international conduct costs table is the fifth we have published and its publication coincides with the tenth anniversary of the start of the Global Financial Crisis. As has been the case since the first table, we find ourselves wondering when, if ever, the level of conduct costs will start to decrease. The new table tells us this has not happened yet, at least when the five-year period ending 2016 is compared with the preceding five year period. There has, in fact, been a 5.2pc increase. (The figures, of course, include provisions as at the end of 2016.)
  • There are perhaps some reasons for cautious optimism. The FCA figures for fines (not all conduct costs) for the year 2016 show a rapid falling off (in fact, to zero). It’s also reasonable to assume that the long running sorry tale of payments and provisions for PPI mis-selling must come to an end eventually although UK banks made additional provisions for PPI mis-selling of more than £1.5bn midway through 2017. The ongoing “Qatar affair” affecting Barclays will no doubt continue for some time, causing further reputational damage, but, in this case at least, the alleged conduct in question (and we must remember that the criminal case is still to be heard in court) did occur some years ago and there have been significant changes in the bank’s senior management in the meantime.
  • All of which raises the question on which “the jury is still out”: has bank conduct really started to improve? We must hope that it has and that the efforts banks say they have been making to make changes for the better are bearing fruit…and that there is more to “restoring trust” than a mere PR exercise. It is a little disappointing that so little has been done to implement a market-wide “standards” agenda in retail banking, as suggested by Sir Richard Lambert in his May 2014 Review but perhaps we will find, as the conduct cost figures for future periods become available, that banks are, one way or another, able to adopt and comply with standards appropriate to an industry that would like to be seen as a “profession”. Time will tell.

(ii) Chris Stears (Research Director CCPRF)

  • Ten years on from the financial crisis, five years into the Conduct Costs Project and the numbers are still striking: GBP264 billion in “conduct costs” (inclusive of provisions) for the 20 banks listed on the international results table for the five-year period ending 31 December 2016. This is a 5pc increase on the previous five-year period. While we might have expected conduct costs to have increased over the period – 2016 was, after all, a significant year as cross-jurisdictional regulatory enforcement actions and various private suits settled and costs crystallised – we would not have expected the level of provisions to remain largely unchanged.
  • If we are to look for an indicator of the effectiveness of the industry’s efforts in changing its culture, promoting good behaviour through appropriate incentives and standards and in managing conduct risk, this Report’s findings make for illuminating reading. Trust in, and the trustworthiness of, the banks must surely correlate to (and be conditional on) banks’ conduct costs. And, the persistent level of conduct cost provisioning is concerning. It remains to be seen whether or not the provisions will crystallise in 2017 (and/or beyond) and what effect this will have on the aggregated level of conduct costs. Since the heights of 2013-14, conduct costs looked to be tracking down (if we assume – perhaps unwisely – that 2016 was an exception to this otherwise commendable direction of travel). However, the target, of course, is not zero; there will always be conduct costs. The question is at what average level will these costs settle? And, moreover, is that level ‘acceptable’; to the banks, their shareholders, the public?
  • Finally, I would add that the identification of conduct costs (and in particular, provisions) remains a challenge where there lacks any intelligible reporting on these costs (and on related provisions – even on an aggregated basis that would reflect the uncertainties and sensitivities inherent in such figures). The Project has, for a number of years, applied a methodology to the identification of conduct costs, and through its annual report, made such costs public. Its work on the development of metrics such as “cause”, “cost” and “culpability” codes has sought to further enhance the analysis of the raw data and offer new insight into the figures (and perhaps an answer to the question over an “acceptable level”), and it does so on a comparative basis.

(iii) Tania Duarte (Operations Director CCPRF)

  • The Conduct Costs Project Report 2017 marks the fifth year of this differentiating project, aimed at shining a light on the level of the conduct costs of the world’s 20 leading banks and contributing to the discussion on what these costs mean.
  • The Conduct Costs Project involves a continuous process of research into, and validation of, conduct costs identified from information available in the public domain. Events that meet the definition of “conduct costs” are recorded against multiple fields. This provides the opportunity to subject the “numbers” to, particularly comparative, analysis. The Project’s report is the culmination of this process. A critical condition for data capture is that it can be traced to publicly available information from not only credible third party sources, but also from the banks themselves. The quality of banks’ disclosures of conduct performance – in the form of conduct costs – is of relevance to questions of risk management, as well as transparency and accountability and the effect that this has on its conduct, culture and people.
  • The Project’s objective of providing an analytical tool and methodology to enable a comparative assessment of banks’ conduct performance is underpinned by a very comprehensive database and covering conduct events from 2008 to 2016. These events provide notable insight into banks’ conduct risk and can be queried for analysis by jurisdiction, year(s), regulator, as well as by event “Cause”, “Cost” and “Culpability” – three metrics developed by the Project that enable the identification of specific risk areas, regulatory risk and accountability insight).
  • Findings from the latest 5-year period (2012-2016), including provisions at the end of the period, reveal a total amount of cGBP 264bn. This represents an increase of c32.0pc when compared with the first research period (2008-2012). These results highlight that, even 10 years after the start of the global financial crisis, the financial consequences of misconduct remain evident and material.

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