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Resolving the banking crisis will require radical surgery and quiet determination

By Ian Fraser

Published: Sunday Herald

Date: August 12th, 2012

STANDARD Chartered, the London-headquartered bank that does most of its business in Asia, was – until the beginning of last week – the last good bank standing. It was one of the select band of banks to characterise themselves as a cut above the rest, having survived the crisis relatively unscathed without the need for state funded bailouts.

To varying degrees Barclays, Clydesdale, HSBC and Standard Chartered all took a “holier than thou” position, seeking to distinguish themselves from tainted brands such as Royal Bank of Scotland by insisting they had avoided scrapes, made fewer reckless decisions pre-crisis, were still lending as usual and had conducted themselves properly by adhering to good corporate governance.

But then came a bombshell from left field in the shape of an Order Pursuant to Banking Law from the New York State Department of Financial Services. It accused Standard Chartered (SCB) of laundering $250bn for Iran and Iran-based clients over a 10 year period which, the regulator said, “left the US financial system vulnerable to terrorists, weapons dealers, drug kingpins and corrupt regimes, and deprived law enforcement investigators of crucial information used to track all manner of criminal activity.”

The August 6 order, signed by Benjamin Lawsky, superintendent of the state’s department of financial services, was unequivocal. It said: “For almost ten years, SCB schemed with the government of Iran and hid from regulators roughly 60,000 secret transactions, involving at least $250 billion, and reaping SCB hundreds of millions of dollars in fees.” Lawsky also labelled the bank a “rogue institution”.

Richard Meddings, SCB’s executive director, was quoted using expletives to disparage America’s insistence on an economic blockade of Iran. He told an official in the bank’s New York branch:. “You f**king Americans. Who are you to tell us, the rest of the world, that we’re not going to deal with Iranians?”

The exposure of the alleged crimes — which make a mockery of Standard Chartered’s attempts to take the moral high ground with its “Collective Good” TV advertising campaign and chief executive Peter Sands’s insistence that the bank is whiter than white — caused the bank’s shares to tank, though they recovered to some extent later in the week. Sands sought to play down the quantity of illicit transactions. However, one top ten institutional investor in the bank was underwhelmed by its efforts to extricate itself from the mire, saying: “Even if it is only $14 million, they have still committed a crime, they are still guilty.”

The revelations, plus the possible loss of Standard Chartered’s New York operating license, are “incredibly damaging and are ruining all the good work that the current management has done in recent years,” said Nic Clarke, banks analyst at brokers Charles Stanley.

Some have sought to minimise the severity of the New York State ruling by arguing that Lawsky is driven by personal ambition. Frances Coppola, a former senior NatWest and RBS banker who now blogs at Coppola Comment, said the New York State order reflected competition between US regulators and their tendency to single out non-US banks rather than domestic players. She described the US regulatory system as fragmented, systemically biased towards its own financial institutions and tending to lean towards regulatory avoidance.

But William K Black, professor of economics and law at the University of Missouri Kansas City, and a former US financial regulator, said arguments about regulatory mission creep are a red herring.  He also said that anyone who fell for the “good” banks’ spin, to the effect that some were on a higher moral plane, was rather gullible.

“What you have in the UK, as we have in the US, is a ‘Gresham’s dynamic’ in the banking sector. That is, banks have been able to gain a competitive advantage by cheating. Bad ethics inevitably drove out good ethics, which gave rise to a pervasive rottenness and not just a few bad apples,” he said.

A Gresham’s dynamic is when “bad money drives out good”. It is named after the 16th century Antwerp-based financier Sir Thomas Gresham, who once explained what was happening to the English coinage to Queen Elizabeth I, as a consequence of the decision of her father King Henry VIII to debase the coinage by replacing 40% of its silver with base metals. The result was that English merchants and subjects hoarded the old, ‘pure’ silver shillings and spent the bad new ones.

William K Black said that since 1999-2000, “the Gresham’s dynamic was accompanied by light-touch regulation, and an environment in which the regulators befriended the regulated and had zero desire to enforce ‘white collar’ criminal laws.” He said that he welcomed the fact that regulators such as Lawsky are committed to breaking apart the cosy relationships between bankers and regulators which, he argued, persist at US Federal regulators including the Securities and Exchange Commission and Federal Reserve.

So  how can the UK deal with the pervasive malfeasance that appears to have infected its entire banking sector – and which is probably a legacy of the Friedman-esque insistence on the supremacy of shareholder value and the switch from a service-led to a sales-led culture in the 1980s and 1990s?

The measures that have been introduced so far, such as proposals from Sir John Vickers’s Independent Commission on Banking for the ring-fencing of UK banks’ retail arms from their “casino” or investment banks, and the parliamentary commission to be chaired by the MP Andrew Tyrie, are seen as inadequate by most campaigners for financial and economic reform. Other measures including  support for the banking sector in the shape of near-zero interest rates, quantitative easing and funding for lending from the Bank of England and European Central Bank are also seen as misguided given that they only serve to prop up a morally bankrupt financial system.

Paul Moore, former head of group regulatory risk and so-called ‘HBOS whistleblower’, who last month set up the New Wilberforce Alliance to campaign for economic and financial reform, said: “The whole banking system is broken and needs total reform. We need a fully transparent, forensic no-holds-barred inquiry in which everyone with a vested interest in further cover-ups, which includes existing and past politicians, existing and past regulators, any City of London grandee, must be barred from taking part other than as a  witness. It should be presided over by three judges and three ordinary British people voted onto the tribunal.”

He went on: “I am a huge fan of Conservative MP Andrew Tyrie but his commission is not going to work. In the light of recent revelations and the post-crisis whitewashes and cover ups, hardly anyone in the UK trusts the politicians, the government, the regulators to handle this any more.”

Among solutions proposed by the alliance and the campaigning group Fair Pensions include that the fiduciary duties of the directors of publicly-quoted companies, including banks, should be amended to encompass public duties. Moore said: “There should be legal obligation not to focus solely on destructive goals such as short-term profit and share-price maximisation.”

Moore also favours a return to full-reserve banking. Under full-reserve banking, banks must retain the funds of each depositor in reserve, either as cash or other highly liquid assets, often deposited with the country’s central bank, rather than use them as seed capital for speculative trades.

He added: “We should also be looking to cut off the heads of the hydra that the banking issue has become, by breaking up the banks into smaller units, creating regional, credit-style banks like landesbanks and credit banks. There has to be a deconstruction of the ‘too big to fail’ institutions and a firm enforcement of the split between their retail and casino arms. That will ultimately deprive the casino arms of the ability to borrow speculative capital for the purposes of gambling in world markets.”

Jim Lindsay, chief executive of Airdrie Savings Bank and president of the Chartered Banker Institute, agrees that “from a purely logical perspective there must be some  benefit in breaking ‘too big to fail’ banks down into more manageable chunks in order to ensure that  management has a tighter grip over what’s going on.” Moore also said that there should be a blanket ban on banks engaging in proprietary trading. “Proprietary trading is an abuse of a dominant position in information, often generated through conflicts of interest, mathematics, and computer science.”

But what about the $1.2 quadrillion of outstanding derivatives contracts that are still floating so dangerously around the global financial markets? How do you neutralize that?

It was the exponential growth of derivatives, including futures and options contracts, as well as more complex ‘bets’ on future financial outcomes including the infamous bundles of toxic debt known as collateralized debt obligations, that caused the financial crisis, after many turned out to be so opaque that they became impossible to value. In some senses complex derivatives became the Dutch tulips or South Sea Company shares of the 21st century.

Moore said the gradual unwinding of speculative positions should be handed along similar lines to the decommissioning of a superannuated nuclear power station. “If there are a lot of dead bodies in a house you have to dig them up and you have to deal with them. It’s a matter now of bringing out your dead.”

RBS chief executive Stephen Hester recently accepted that there might still be some horrors along the lines of the Libor rigging scandal lurking in the rapidly diminishing Gogarburn-based empire (listen to Hester admitting that the banking industry “became a bit detached from society”, in an interview with BBC Radio 4 Today‘s John Humphrys).

Jim Lindsay suggests that the process of owning up to past malfeasance, if there is more to come out, is something banks should do sooner rather than later. “It would be better if everything of that ilk could emerge now. You can’t have something that happened five years ago coming out in a further five years. It would be better for all of us if that comes out now.”

However Lindsay said the primary focus of the Chartered Banker Institute is on change from within:  “If trust is to be re-established in the banking sector, we need a sustainable foundation of professionalism.” That was why the institute  had launched the Chartered Banker Professional Standards Board last October, he added.

Lindsay said the chairmen and chief executives of all nine of the major UK clearing banks have signed up to the initiative, and agreed to fund its development. The goal is to try to bring back elements of the culture, which has evaporated since the 1980s, that bankers are professionals who need qualifications. The standards, which are still in development, aim to measure individual bankers’ ethical awareness, their customer focus and their professional and technical integrity. He continued: “The goal I nothing less than a reinvention a reinvigoration of our banking profession.”

Others have harsher medicine. Professor Black said that, in order to break the Gresham’s dynamic that, in his view, still grips the industry, it is essential that all bankers who had broken the law, faked accounts, defrauded customers, and opened their doors to pariah states are banished from the industry. He said: “You need to get rid of the old scum who told us they were leading us in a dance but who were actually leading us to a disaster. The critical things is that they are removed from office and disgraced. Trying them all might be too difficult.”

Rowan Bosworth-Davies a former Scotland Yard fraud squad officer and head of investigations at FSA predecessor FIMBRA said: “I think we need a groundswell of popular pressure to ensure governments realise they can no longer get away with sweeping bank crimes under the carpet. David Cameron and George Osborne could start off by refusing to attend City lunches and dinners – along similar lines to what we did to the South African cricket team under in the apartheid era. We need them to say: ‘We’re not going to be part of your ceremonies and shibboleths. You people are beyond the pale.’”

 

Image: WilliamBanzai7 This was the business focus article in the Sunday Herald on August 12th, 2012. It was published under the headline “Banking industry must rebuild from new foundations“.

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