Banking Crisis: reforming corporate governance and pay in the City - Treasury Contents

1  Introduction

1. When invited to comment on the genesis of the current crisis, Jon Moulton, of Alchemy Partners, argued that "a wall of cheap debts, asset inflation much accelerated by securitisation, complex financial products, and a grotesque failure of every regulatory system and governance system in the entire set-up" were responsible.[1] While other witnesses pointed to different factors, there has emerged a consensus that there is no single cause of the current crisis: many factors and many actors have played their part—not only the banks but also accountants, auditors, credit rating agencies, hedge funds, shareholders, the public, the regulators and the government. In this report we seek to disentangle some of these intertwined contributions to our present problems.

2. Professor Michael Power, an authority on accounting practices, described to us the existence of a web of assurance that contributed to financial stability:

financial auditing operates as part of a wider network of mutual assurance and co-dependency, we should pay more attention to this network and its characteristics. Financial auditing is just one of a number of different "lines of defence" which, though having different objectives, are also related in the overall production of financial stability. For example, management itself is always a first line of defence, aided by quality control processes close to the front end of business. Internal auditors and risk management units provide a further layer of defence. Financial auditing, regulatory supervision, credit rating and even insurance markets provide further elements of the network.[2]

3. This report develops these ideas further by examining the role of various market forces and non-public sector actors in this crisis. We begin by examining remuneration and risk to see how the prevailing ethos in the financial sector affected people's behaviour. We examine whether there should be regulation in this area. We then look at other ways in which non-public regulation operated. These included the way boards have behaved, how shareholders have contributed, what part credit rating agencies have played, how auditing and accounting standards have operated and finally what role (if any) the media has played in affecting the course of the crisis. Our report is intended to feed into the independent review of corporate governance within the UK banking industry, which is being chaired by Sir David Walker and which will look at many of the areas we have examined. Sir David will publish his preliminary conclusions by autumn 2009 with final recommendations expected by the end of this year.[3]

4. This report is the third of a series of four reports on the Banking Crisis. It follows on from those we have produced on Banking Crisis: the impact of the failure of the Icelandic banks and Banking Crisis: dealing with the failure of UK banks. We shall consider the public regulatory framework and the role of the tripartite authorities in a later report.

5. The terms of reference, witnesses and timescale for this report are all set out in the introduction to our report on Banking Crisis: dealing with the failure of UK banks so we will not repeat them here.[4] Once more we have been well aided by our specialist adviser, Professor Geoffrey Wood of the Cass Business School, London to whom we are most grateful.

1 1   Q 725; A full list of witnesses for this inquiry can be found at Treasury Committee, Banking Crisis, HC 144-I, pp1-4; written evidence can be found in HC 144-II and HC 144-III. In this report references to oral evidence are to the first of these volumes and prefaced by Q or Qq to refer to the Question number; written evidence relates to the second and third volumes. Ev p or pp refers to these, with pp 1-590 appearing in vol II. Back

2 2   Ev 174 Back

3 3   "Independent review of corporate governance of UK banking industry by Sir David Walker", HM Treasury Press Notice, 9 February 2009 Back

4 4   HC 402, Fifth Report of Session 2008-09; HC 416, Seventh Report of Session 2008-09 Back

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