Banking Standards

Written evidence submitted by the Centre for Research on Socio-Cultural Change (CRESC) (S005)

Executive summary [1]

• ‘Culture’ is commonly invoked as the ideal cause of recent banking catastrophes. But this neglects the obvious question: what sustains and animates a practically defective and morally deficient culture?

• We argue that it exists in more material conditions: in particular, culture can only be understood in the context of the kind of business models which governed banking, especially investment banking, before the great crisis, and which still govern banking practices. The Libor scandal is therefore important not only for itself; it is symptomatic of a wider crisis of the banking system.

• It follows that reform cannot be fully effective if it relies on trying to change the hearts and minds of bankers, nor on a more closely controlled and centralised system of regulation, nor on a reform of Libor itself. What is required is fundamental reform of banking institutions and practices to transform the banking business model.

• We use recent scandals involving Barclays and HSBC to illustrate our arguments but contend that these two giant banks are by no means unique.

• We show that under existing business models, banks have become loosely controlled federations of money making franchises in which the pursuit of reward by senior executives has overridden both the interests of shareholders and the wider social obligations to which banks, like all businesses, should be subject.

• We show that reform cannot be achieved by bankers, boards and regulators acting alone, nor by moral injunctions to behave better. Effective reform to change the business model requires the use of the authority and legitimacy which only the democratic state possesses. This makes the recommendations of the Commission especially important. Since banking, and the wider City, have in recent years come to exercise a disproportionate influence over the executive, parties and Parliament, radical recommendations will demand courage from the Commission.

• We conclude with eleven recommendations which are designed to reshape banking practices, to rebuild a socially responsible business model and to reshape the world taken for granted of bankers. These include separating investment from retail banking, creating a more diversified banking industry, and opening up the world of banking and finance to more democratic influences.

When definitions matter

‘Culture is one of the two or three most complicated words in the English language’

Raymond Williams, 1983

(1) In his first public apology for Libor fixing, Bob Diamond said ‘I am sorry that some people acted in a manner not consistent with our culture and values.’ [1] That apology set the register for the establishment’s account of what has gone wrong with banking in Britain – as we document below, the assumption is that banking has a cultural problem and we all know what culture means. But invoking ‘culture’ is not enough, especially when a complicated and contestable word is being used in an unexamined manner.

(2) Definitions do matter. Our argument in this submission is that the thoughtless and unexamined invocation of a common-sense ideational concept of culture by practical men has encouraged misconceptions about the nature of the moral and political crisis caused by finance in London. And the problem needs reframing using a material definition of culture before effective reform can be introduced.

(i) Ideational culture and the expressive model vs. material culture and the performative model

(3) Bob Diamond’s choice of words are an example of a ‘practical’ man using a common sense concept of culture and a model of how the world works: he implies that banking culture is some kind of ideational motive or value which is (or should be) expressed in behaviour. These tropes about ideational culture expressed in behaviour, recur in most of the subsequent discussion by politicians and regulators who, like Mervyn King, wanted to have ‘a change in the culture of the banking industry.’ [2] Thus David Cameron argued: ‘The most important thing people want to see is a really concrete set of actions that will help change the culture. You don't change culture by changing laws and changing regulations alone.’ [3]

(4) This definition of culture and the expressive model of behaviour was then carried over into the terms of reference of Barclays’ own internal inquiry into rate fixing. It also carried over into the external Parliamentary Commission on ‘professional standards and culture of the banking sector’ which was announced after the government had set itself against a broad ranging, Leveson-style inquiry into the banks and persuaded the parliamentary opposition to accept a far more narrow, technical and depoliticized inquiry into what went wrong with the practice of setting the Libor. [4]

(5) Here is the Barclays press release which announced that Anthony Salz is to conduct an independent review of Barclays’ culture which will conclude by next April.

"The global review will assess the bank’s current values, principles and standards of operation and determine to what extent those need to change; test how well current decision-making processes incorporate the bank’s values, standards and principles and outline any changes required; and determine whether or not the appropriate training, development, incentives and disciplinary processes are in place". [5]

(6) In the case of the Parliamentary Commission, the standard definitions and model structure is used as the framework for the (leading) questions which the inquiry sets those seeking to make written submissions. The Commission’s questions are about culture and standards in ways which are orthodox but have the unfortunate effect of reinforcing its narrow terms of reference in two key respects.

(7) First, the Commission’s questions suppose ideational culture and the expressive model. They start from the assumption that there is a problem about ‘professional standards in UK banking’, and standards in common usage are of course always about behaviour and outcome. The first possible cause of the standards problem in their question 4 is the ‘culture of banking’ understood implicitly as the stuff of ideas and values.

(8) Second, standards and culture have a material and external frame but this is defined very narrowly in terms of what upsets culture /standards. Thus question 4 brackets culture with the ‘incentivisation of risk taking’ (by individual agents?). The sectoral conditions of upset are exogenous developments like ‘financial innovation’ or ‘technological developments’. The firm level conditions of upset include the activity mix of retail with investment banking, the level of competition and weaknesses of control apparatus (primarily corporate governance via shareholders, directors, audit and regulation)

(9) The Parliamentary Commission’s framing of the problem does no more than mirror the self-knowledge of bankers like Bob Diamond and the common sense of politicians and regulators. But this shared ideational concept of culture and the expressive model of how the world works are both confused in ways which prevent us identifying what has to change if we are to have better, more socially responsible banking. The ideational notion of ‘culture’ is misleading because it implies that some kind of cultural cleansing is possible. This could involve sacking or mentally reprogramming the most irresponsible individuals who personify the ‘bad culture’ of greed. This would then allow the ambient ‘good culture’ of corporate responsibility to flourish. Like giddy, overexcited children who knock things over at parties, it is assumed bankers can be taught to calm down and behave by giving them a stern talking to by a non-executive director (NED) or a lecturer in business ethics. And this follows in the lineage of one of the most popular framings of the financial crisis as the result of out of control greed amongst key individuals.

(10) Against all this, our submission makes a counter argument as follows:

a. Culture is not an ideal or value in the hearts and minds of men who can be cleansed or reprogrammed. Culture is something material that is embedded in organisational structures and the specifics of the business activity which define everyday norms about what is permissible and how employees can avoid getting into trouble.

b. In banking, the structures and specifics are sui generis because household name banks (like Barclays or HSBC) are not unitary organisations but loose federations of money making franchises; in the case of PLC banks, the federations are driven by the pursuit of shareholder value and bonuses in a kind of joint enterprise between shareholders and senior investment bankers which defines the business model.

c. Tighter regulation and governance will deliver few benefits unless such controls prioritise reform of the investment banking business model. A shift in the investment and retail business model is the absolutely critical precondition of any meaningful change in behaviour.

d. Reform of the banking business model raises issues of control which are beyond the domain of corporate governance for shareholders, or of banking regulation narrowly considered as a matter for the Bank of England. This is because non-executive directors or regulators lack the political authority to spoil a profitable business model in a world where private and social interests diverge and the interests of elite investment bankers are defended by the Westminster political classes.

(11) The submission which makes these points is organised in a straightforward way. The next two sections propose a material definition of culture by considering evidence about organisational behaviours that has emerged from recent official inquiries into Barclays and HSBC. The argument then turns to examine the Barclays business model before a final section turns to consider the political difficulties of reform.

(ii) Banks as unitary organisations vs. loose federations

(12) In a now notorious public lecture for the BBC Today programme, Bob Diamond said ‘Culture is difficult to define … but for me the evidence of culture is how people behave when no-one is watching.’ Here again he takes an entirely orthodox position on ideational culture and assumes the expressive model. Within this frame, in the special case when nobody is watching, internal values will of course directly determine behaviour. [6] But this leaves out a key feature of institutional life: organisational design and controls structure routine performance whether or not anybody is watching. This material culture position is supported by the evidence of senior bankers when questioned about investment bank rate fixing by the UK Treasury Committee and about money laundering in a US Senate hearing. We are already indebted to the work of anthropologists like Joris Luyendijk and Karen Ho who have described the processes of selection, acculturation and precarious attachment which produce a dangerously conformist mentality inside banking firms where employees operate within silos. But the recent public testimony by senior bankers In London or New York suggests that the (loose) internal organisation of giant banks makes them unfit for purpose.

(13) Let’s begin with some generalities which should be familiar to anyone who has done an introductory course in organisation studies. A firm is a space of bureaucratic coordination which requires internal hierarchy and division of labour that implies expectations and rules about what can and cannot be done at different levels, and runs partly on active instructions and permissions from top to bottom. Any organisation then requires individual and group initiative because rules and instructions cannot be complete, so improvisation is required. But such improvisation operates within procedural limits so that, for example, authorisation of expenditure or breach of standard procedure usually requires some kind of signing off and a paper trail.

(14) All this is a mixed blessing. The firm or any other large organisation is for bureaucratic reasons typically an inflexible, unreflective economic and social actor with a limited capacity to respond to how things have gone wrong, or indeed to recognise that things have gone wrong or will go wrong. Consider BP’s succession of accidents and environmental disasters after the Browne-led mergers had created a much larger firm where operating control was a major unresolved problem; or, worse still, think about how a disastrous combination of hierarchy and institutional baronies encouraged the Catholic Church to cover up child abuse in many jurisdictions.

(15) But the investment bank illustrates two different problems which make investment banks like Barclays or retail banks like HSBC positively frightening, not just poorly controlled like BP or unintentionally vicious like the Catholic Church. On the basis of testimony in London and New York, the present day investment bank is a thoroughly informal organisation where many things, including gross rule breaking at middling levels, can go on without formal authorisation.

(16) On Monday 16 July 2012, Jerry del Missier, the recently departed chief operating officer of Barclays appeared before the Treasury Select Committee and gave an account of how Barclays came to ‘lowball’ its Libor submissions in the aftermath of the phone call of 29th October 2008 between Paul Tucker of the Bank of England and Bob Diamond at Barclays, which led Diamond to produce an email note. There was, to put it neutrally, a misunderstanding at this point about whether the Bank was instructing Barclays to lowball (because of the public interest in making Barclays look sounder than it was).

(17) The interesting point is that, along the internal chain of command at Barclays, all the instructions were verbal and the instructions were accepted without demur, even though the instruction was for Barclays to do something irregular at the (second hand reported) invitation of the Bank of England. The internal chain in Barclays Capital ran from Bob Diamond (who took Tucker’s call) to Jerry del Missier as co-head of investment banking, and then to Mark Dearlove as head of the money market desk. ‘Yes it was’ an instruction said del Missier in his July testimony when he claimed he had ‘passed on the instruction as I received it’. And how did Del Missier receive it? The Financial Times reported: ‘in a phone conversation the day before he received the email note’ from Diamond which did no more than report another phone conversation with Tucker. Diamond did prepare a ‘file note’ which went to the CEO of Barclays as well as del Missier; but neither asked for an internal meeting or any kind of confirmation of what the Bank of England wanted.

(18) Let’s pause here. Barclays is clearly not an organisation of the staid, formal kind which most civil servants or academics will be familiar with. Let us hypothetically suppose the nearly unthinkable. Some senior authority outside our University (for whatever reason) wants to adjust the academic grades on our degree programmes so as to deliver more good honours degrees. That would require written orders down the chain, then a series of committee meetings so that all those affected could discuss any concerns about issues of authority and implementation. And the committee chairs would be expected to have a written instruction from an external point of origin after, for example, the university’s academic registrar had forwarded an authoritative outsider’s direct and explicit email instruction to fix the grades with some supporting reasons. (Our university registrar’s recall of the sense of a phone call would not be any basis for action).

(19) Such bureaucratic safeguards are more elaborate in public sector organisations which spend taxpayers’ money and must identify the public interest. But they would be familiar to most managers in private sector companies. Consider, for example, another hypothetical example of a car company instructed (by authority, for whatever reasons) to falsify CO2 emissions of a new model. In this industry (which we have previously researched) it is routine to tune car engines, by varying injection and ignition timing, which reduces ‘drivability’ but gets test cycle emissions below key thresholds that will affect sales or taxation. But no individual or group in a major car company would return a false test result without written authority and extensive internal committee discussion.

(20) The difference of practice here is not public vs. private but banking vs. the rest. The investment banker’s counter argument is that formal bureaucratic safeguards are quaintly inappropriate in the fast moving world of banking where the principle has to be ‘just do it’ because there is no time for all this procedural stuff which still regrettably clutters up the hierarchical public sector and manufacturing companies. But that raises a serious question. What protects economy and society if the investment bank (as organisation) does without the bureaucratic safeguards which in other organisations protect us from compounded misunderstandings and active malpractice? Because, in this world of informality, orders are passed on without question as junior bankers at desks will simply follow verbal orders from their seniors while (on the testimony of Diamond and others) senior bankers may have a very limited knowledge of what is informally going on at the lower levels.

(21) Just as amazing in terms of informality was Mr Tucker’s explanation, as regulator from the other end of the phone line, about why the Bank of England had no recording of his conversation with Bob Diamond. According to Tucker, no record was kept of many phone calls within the Bank of England because the press of crisis made this impossible. One might have expected that the press of crisis, which was forcing numerous commitments out of public institutions like the Bank, would precisely have made imperative an accurate, permanent recording of communications. But just as the banks were captives of a ‘just do it’ mentality, the central bank was, and remains, captive of its historic relationship with markets, which pictures the Bank as an informal and informed regulator better able to do the job than ‘inflexible’ bureaucrats in Whitehall.

(22) The back stop social protection is then supposed to be supplied internally by a bank’s internal compliance department which enforces standards and polices wrong doing. But, the ineffectiveness of such arrangements was dramatized when senior HSBC executives appeared before a US Senate hearing in July to explain how and why HSBC had, despite repeated US regulatory censure and internal whistle blowing, continued to allow drug proceeds from Mexico to be laundered through the bank and allowed terrorist financiers to obtain US dollars.

(23) The central institution in this story is HSBC’s largest US affiliate: HSBC Bank USA (or HBUS) is key because it provides HSBC’s overseas clients with access to dollar markets and the US financial system, which is important because the dollar’s role as leading trade currency makes it a prime target for launderers. Between 2007 and 2008, HSBC’s Mexican affiliate, HBMX, shipped $7 billion in physical US dollars to HBUS, more than any other Mexican bank, even one twice HBMX’s size. According to the senate Chair’s report:

"HBMX operates in a high risk country battling drug cartels; it has had high-risk clients such as casas de cambios; and it has offered high risk products such as US dollar accounts in the Cayman Islands, a jurisdiction known for secrecy and money laundering. HBMX also has a long history of severe AML deficiencies. Add all that up and the US bank should have treated HBMX, the Mexican affiliate, as a high risk account for AML purposes. But it didn’t. Instead, HBUS treated HBMX as such a low risk client bank that it didn’t even monitor their account activity for suspicious transactions. In addition, for three years from mid-2006 to mid-2009, HBUS conducted no monitoring of a banknotes account used by HBMX to physically deposit billions of US dollars from clients, even though large cash transactions are inherently risky and Mexican drug cartels launder US dollars from illegal drug sales. Because our tough AML laws in the United States have made it hard for drug cartels to find a US bank willing to accept huge unexplained deposits of cash, they now smuggle US dollars across the border into Mexico and look for a Mexican bank or casa de cambio willing to take the cash. Some of those casas de cambios had accounts at HBMX. HBMX, in turn, took all the physical dollars it got and transported them by armoured car or aircraft back across the border to HBUS for deposit into its U.S. banknotes account, completing the laundering cycle."

(24) In addition to the cross border movement of physical notes, it was also found that HSBC affiliates in Europe and the Middle East circumvented filters set up by the US Treasury Department’s Office of Foreign Assets Control (OFAC) to prevent the funding of terrorist organisations: references to Iran in $19bn worth of US dollar transactions between Iranian entities and HBUS or other US affiliates were stripped out of or omitted from paperwork in 85% of cases, in full knowledge of HSBC’s Chief Compliance Officer and other senior executives in London. There were similar allegations of negligence and cover-ups made regarding HSBC’s ties with the suspect Al Rajhi Bank; clearing travellers cheques for suspicious Russian used car business via a Japanese bank; and offering accounts to ‘bearer share’ corporations, which due to their anonymity are prime vehicles for money laundering and other illicit activity.

(25) Why was the internal compliance department so completely ineffectual and why did senior London management fail to engage with the funny business coming out of Mexico? The short answer is that HSBC was less a bureaucratic organisation and more a loose federation of franchises organised on an ask-no-questions basis. The senate report makes it clear that HSBC Group HQ in London instructed its affiliates to assume that every other HSBC affiliate met the group’s AML standards and so should be provided with correspondent banking services. HBUS merely followed this instruction, ignoring more stringent US law which requires due diligence reviews before any US account can be opened for a foreign bank. David Bagley, HSBC’s chief compliance officer since 2002, admitted to the US Senate that his position lacked any power. As the FT reported, on his own testimony, David Bagley did not control compliance in national affiliates like Mexico because his job was only ‘to set policy and to escalate issues that were reported to him’.

(26) Bagley’s testimony was front page news partly because of his resignation from the job on the day he testified. But, the largely unreported parallel Senate testimony of Paul Thurston, HSBC chief executive for retail banking and wealth management, was even more devastating; not least because it described an absence of control and rules in retail banking where customers and regulators would quite reasonably expect them. The key exchange was with Senator Levin:

Sen. Levin: Why did these things fester for so many years at this bank [HSBC Mexico]? This isn’t something discovered in hindsight, this is something that people knew was going on at that bank. Why was it allowed to continue?

Thurston: The business model was complicated and decentralized. It was very difficult for the center to get controls.

(27) The difficulty of central control was separately explained by Thurston:

"It became apparent that decision-making processes concerning anti money laundering were not satisfactory [at HSBC Mexico]. Over time, it also became clear that this was not only a question of process and technology, but that the underlying business model needed to be examined. Branch managers operated as local franchise owners, with considerable autonomy and a focus on business development, reinforced by an incentive compensation scheme which rewarded new accounts and growth, not quality controls."

(28) Banks and banking are defined in most dictionaries in terms of business conducted and services offered so that retail banks take deposits and make loans, investment banks advise on merger and engage in prop trading. In organisational terms, after last July’s testimony by Barclays and HSBC execs, it might be fairer to describe a bank as a loose federation of money making franchises (with always troubling and sometimes dire economic and social consequences)

(iii) The boundaries of the firm

(29) The bank as a federation of money making franchises is a troubling idea and even more disturbing is the consequence that some senior franchisees will not only be working for the bank but working for themselves, and with franchisees in other firms. In this case, the firm would have no definite boundaries of the kind presupposed in most studies of bureaucratic organisations. If this seems far-fetched and fanciful, consider the terms in which the Financial Services Authority (FSA) indicted Barclays for libor manipulation. The staid FSA prose is startling because it reveals collusion by bank employees in one firm to benefit traders operating in another firm. Paragraph 8 of the FSA proceedings reports that:

"Barclays acted inappropriately and breached Principle 5 on numerous occasions between January 2005 and July 2008 by making US dollar LIBOR and EURIBOR submissions which took into account requests made by its interest rate derivatives traders (‘Derivatives Traders’). At times these included requests made on behalf of derivatives traders at other banks. The Derivatives Traders were motivated by profit and sought to benefit Barclays’ trading positions." (our emphasis added)

(30) Thus, employees from Barclays were willing to manipulate their own institution’s reported borrowing rates, (with uncertain effects for their employer), to benefit a trader at a competitor. This observation of collusion is important because it indicates that the boundaries of the firm are fluid and permeable as working structures involve building and maintaining interpersonal networks across firms which allow employees in one firm to work for the benefit of employees in another firm who needs a profitable trade

(31) This collusion relates to activity specifics in investment banking when the presence or absence of profit on a particular trade, or at the firm aggregate, relies on the quality of the numerical inputs and valuation models used when assigning a price to often complex derivative assets on the balance sheet. Banks are conversion centres: they turn assets into income streams and income streams into bonuses. When derivatives traders ask someone on the cash desk of another bank to fix LIBOR, this affects the value of an asset which then flatters the return on that trade. Strictly it produces, not profit, but the appearance of profit which is good enough for an employee who wants to book a positive return.

(32) Of course Barclays no longer uses LIBOR to price many of its interest rate products. The game moves on. It now uses much more complex calculations to value its assets. On its valuation of collateralised interest rates it uses:

"Overnight Index Swap (OIS) rates…to reflect the impact of cheapest to deliver collateral on discounting curves, where counterparty CSA (Credit Support Annex) agreements specify the right of the counterparty to choose the currency of collateral posted".

And on interest rate derivatives:

"Interest rate derivatives cash flows are valued using interest rate yield curves whereby observable market data is used to construct the term structure of forward rates. This is then used to project and discount future cash flows based on the parameters of the trade. Instruments and optionality are valued using a volatility surface constructed from market observable inputs. Exotic interest rates derivatives are valued using industry standard and bespoke models based on observable market parameters which are determined separately for each parameter and underlying instrument. Where unobservable a parameter will be set with reference to an observable proxy. Inflation forward curves and interest rate yield curves are extrapolated beyond observable tenors". [7]

What does that mean?

(33) When assets are priced using inputs of uncertain verity which are run through models of great complexity, several games can be played, sometimes simultaneously. Such convoluted calculations are often designed to avoid writing down the value of assets and thereby deliver the impression of solvency. But, more generally, the financial sector has become acutely aware of the signalling power of active numbers reported to elicit an effect in the future, rather than passive numbers designed to faithfully depict an image of the present. Thus LIBOR is not the rate at which unsecured funds are accessed, LIBOR is the signal to investors that everything is under control, or that a trade has been particularly profitable.

(34) So what is the purpose of the firm under such circumstances of intra-firm signalling and extra firm collusion? This is all very different from classical ‘theory of the firm’ literature, where signalling is not envisaged and firm boundaries are rigid. The reason for rigid boundaries is different in various traditions: firms with boundaries exist to minimise transaction costs in the Coasian perspective, firms exist to manage agency problems in the Jensen and Meckling perspective, or firms exist to protect and coordinate certain skills and competences in the Teece et al perspective. But, in different ways, all of these theories presume that the firm ‘contains’ activity on some rational basis and in doing so performs some functional purpose for the broader economic good. As a corollary the firm has interests which management employees should defend.

(35) None of this adequately explains collusion and signalling in investment banking. This behaviour suggests that the bounded firm and its interests are no longer primary because its elite workforce has captured the institution so that the purpose of the firm is to serve the elite. The outcome is akin to what Akerlof and Romer described as ‘looting’, which involves maximising individual rewards at the expense of the institution when accounting is poor, regulation is lax and there are few penalties for abuse. In looting, managers take from the trading profits and the institution is left with the liability. [8]

(36) A large complex investment bank is an ideal site for looting activities as the firm institutionalises opportunities for insiderism, when it is one way or another on both sides of many trades either in its own right or when acting for clients. Put another way, the bank is a machine for generating asymmetric information from which private gains are made as strategies of position, disguise and deception within and beyond the firm are incentivised.

(37) Many politicians and regulators find it difficult to conceive of banks as organisations that institutionalise inside trading opportunities. For most of the 1990s and 2000s, regulators were absorbed by discussions about market efficiencies, financial innovations that improved intermediation and capital allocation, new whizz-bang models that distributed risk and the need for light touch regulation to liberate the sector. They then failed to register that modern banking is particularly prone to looting, because of the opportunities for insiderism in large complex institutions and because the looting can go on as long as the institution remains solvent, which is a long time when there is a state bailout guarantee.

(38) The result is banks as towers of assets built on the quicksand of confidence with opportunities for manipulating profits, sometimes by collusion between insiders and outsiders across firm boundaries. In this case, the most fundamental institution of the capitalist world, the public limited company, is being arbitraged in the interests of an elite workforce inside and outside the firm.

(iv) The business model (and the madness of Barclays)

(39) At this point in the argument we turn to analysing the banking business model of large, complex financial institutions. This is relevant for several reasons. To begin with, we have observed that irresponsible dysfunctional behaviour is related to a series of organisational characteristics inside banks (excessive informality, loose federal structures, and permeable boundaries around the firm). All this could be very easily understood as a kind of disorganisation, i.e. informality is the absence of the principles which properly structure other kinds of organisations. Instead, we would wish to argue that the characteristics represent an active kind of misorganisation, i.e. informality and permeability are the organisational corollary of a business model where the firm has been captured by senior employees.

(40) Put directly, the weakness of the organisation and the discretion of individual investment bankers is what we would expect given the bank business model which primarily supports looting by employees (and in doing so puts shareholders second and the public interest nowhere). We concentrate on the post-crisis present day because all discussion of pre-2008 irresponsibility is met with arguments that, of course, much has changed. As we shall see, not enough has changed. At this point, we turn also to financial numbers from bank report and accounts where we will use Barclays most recent accounts for illustrative purposes. It should be said that standards PLC accounts are not very informative if we are trying to figure out what is going on inside large, complex, financial institutions. But, we would argue that the aggregate accounting numbers on large, complex banks strongly suggest that senior investment bankers are behaving irresponsibly in claiming trading assets which generate feeble returns but underwrite their continued high pay (and that is a kind of looting at the expense of private shareholders and the public interest). Analysis of accounts at company level is important because it shows that language about looting by senior employees is not exaggerated and we are not constructing an overly dark view of banking from a few anecdotes.

(41) We chose Barclays as the illustration for several reasons. To begin with, Barclays is now widely considered to be the classic example of a bank with a cultural problem. Barclays was the first major bank to admit collusive Libor rate fixing and there clearly was a breakdown of trust between its now departed senior management and the FSA which was unnerved by successive instances of rule bending and merely formal compliance. While all this is true, it misses the crucial point that Barclays was and is not so much a bank with a bad culture as a bank with a mad business model which is performed in all kinds of dysfunctional ways that won’t be stopped by simply getting rid of Bob Diamond and his senior staff. And, worse still, on our preliminary calculations, the key numbers and ratios in other banks are not massively different from those in Barclays, which is fairly representative of large complex financial institutions that generally share not a bad culture but a mad business model.

(42) But what is the business model of Barclays and the other large complex banks? It has three elements, disclosed, undisclosed and absent.

a. The first, disclosed element is the public commitment to shareholder value, especially in the form of declared return on equity (ROE) targets which by 2012 are now about getting back to the good old days of 15% or higher ROE achieved (through leverage) in 2008.

b. The second, undisclosed element is maintaining the pre-conditions of looting by senior and high paid employees. The key precondition is retaining a large pile of assets in the investment banking division; and this is crucial because senior employees are paid according to turnover under some variant of ‘comp ratio’ system i.e. on an understanding that the total pay bill will account for some fixed proportion of net turnover after expenses.

c. The third absent element is any safeguard for the public interests in a sector where the private and social interests in preventing accidents do not coincide and where the public is one way or another on the hook for bank bail outs, liquidity injections and guarantees if and when the assets turn into liabilities or markets freeze. So before 2008 there was no limit on levering returns for shareholders though that would dump liabilities on the public in the ensuing down turn; and, after 2008, there has been no limit on piling up low return assets which benefit nobody except senior employees.

(43) Let us now see how this plays, beginning with the public, disclosed business model element. ‘Diamond vows to try harder as Barclays disappoints’ was how the Financial Times of the 10th February 2012 reported Bob Diamond’s presentation of Barclays disappointing financial results for 2011. The CEO admitted that the bank had made an ‘unacceptable’ 6.6% ROE. ‘I am not satisfied with these returns. I care about this a lot … it is important to shareholders. We have a lot more to do’. At the same time Bob Diamond reiterated his commitment to his target of 13% and insisted that ‘if it wasn’t for the external factors we could still do it (and) we’ll make steady progress next year’.

(44) Any calculation of ROE confirms Diamond’s point that shareholders have not done well from the Barclays business model since the financial crisis began. ROE can be calculated in several different ways using slightly different numerators and denominators; while time series calculations of Barclays ROE are complicated by the bank’s acquisition of substantial parts of Lehman’s business after the crisis of autumn 20008. Table 1 presents our own calculations of aggregate company-wide ROE and table 2 presents the slightly different calculations made by Barclays which break ROE down by line of business.

Table 1: Barclays PLC returns on shareholder equity and assets

Return on average shareholder equity

Return on average total assets

Return on average total assets

Total shareholder equity

Pre-tax profit (continuing operations)




































Source: Barclays 20-F.

Notes: Shareholder equity includes capital injection -note the underlying profit has not collapsed. Total shareholder equity is not the same as average shareholder equity.

(45) On our calculations, Barclays current company-wide return on shareholder capital of around 6% is well below the 15% level achieved before the crisis in 2008. Barclays own calculations, based on allocating equity capital to business lines, are even more interesting because they suggest that ROE in investment banking is currently well below the level achieved in the bank’s quality retail businesses. The company’s calculations of ROE by line of business present two different measures (adjusted or statutory) and we prefer adjusted because it excludes various exceptional items. On this basis, according to Barclays own calculations, return on equity is higher in UK retail and Barclaycard which can both hit 15% whereas the investment banking division Barclays Capital does no better than 10%.

Table 2: Barclays PLC return on average shareholder equity (as published in Barclays 20-F)

Return on average shareholder equity (ADJUSTED)

Return on average shareholder equity (STATUTORY)



UK retail



Europe retail



Africa retail






Barclays Capital



Barclays Corporate



Barclays Wealth



Investment Management



Head Office






Source: Barclays 20-F.

Adjusted performance measures exclude the impact of own credit gains, gains on debt buy-backs, loss on disposal of a portion of the Group’s strategic investment in BlackRock, Inc., impairment of investment in BlackRock, Inc., provision for PPI redress, goodwill impairment and loss/gain on acquisitions and disposals. The adjusted return on average equity and the adjusted return on average tangible equity represent adjusted profit after tax and non-controlling interests (set out on pages 274 to 276) divided by average equity and average tangible equity, excluding the cumulative impact of own credit gains of £2,708m (2010: 391m gain, 2009: £1,820m loss) recognised in Head Office and Other Operations.

(46) This first calculation of return on equity by line of business, encourages us to dig deeper and consider Barclays sources of income and return on assets in different business lines. As Andrew Haldane has emphasised, banking before 2008 was often about leverage which boosted ROE but trashed return on assets (ROA). The question is rather different and even simpler by 2012. Where’s the ROA on the large pile of assets held within the investment banking division? And, if these assets are low return in term of ROA profitability, what ‘s the rationale for this allocation which only clearly benefits senior investment bankers whose pay effectively relates to turnover and volume.

(47) The starting point in this analysis has to be the observation that trading (which was central to investment banking profitability for fifteen years before the crisis) is not and has not been an engine of profit for Barclays because it does not generate a large proportion of the bank’s income. As table 3 shows, the percentage of Barclays’ income derived from trading in 2011 stands no higher than 23%, while the interest income (mainly) derived from old fashioned banking intermediation between depositors and borrowers is substantially higher at some 37%. This is not a recent post-crisis development because in 2007 the percentage of income derived from investment is lower and intermediation accounts for no less than 41% of Barclays income.

Table 3: Barclays PLC income by type, 2007 and 2011







Interest income





Fees and commissions




















Gain on buy backs














Source: Barclays 20-F

Notes: Excludes write-offs

(48) Of course, such classifications tell us about what Barclays does and also about how it chooses to represent its activities. A further one quarter to one third of Barclays’ income appears under the heading of fees and commissions, which arise from retail and investment banking. It may be that Barclays is, like JP Morgan, now increasingly wily about reclassifying its trading activities under other headings because US regulators disapprove of own account prop trading. But the proportion of Barclays income derived from fees and commissions has fallen in recent years and the supposition must be that retail (before and after 2008) has generated a bigger lump of profit than investment banking.

(49) Both traditional retail and post-1990 investment bank trading are asset intensive and (as and when things go wrong) the asset pile will generate huge liabilities for the taxpayer. It is not possible to be precise about what proportions of Barclays’ assets and liabilities arise from retail and investment banking but the pile is huge and a substantial proportion of the total arises from investment banking activity. Table 4 summarises relevant sections of the 2011 accounts which show a bloated balance sheet and huge credit risk. In 2011, Barclays credit risk is £1,795 trillion i.e. this one bank has a credit risk larger than nominal British GDP of £1,500 trillion. And nearly half of that is in derivatives and off-balance sheet liabilities, driven by investment banking that is generating paper whose future realisable value is often uncertain. Meanwhile, old fashioned loans account for no more than one quarter of the bank’s credit risk.

Table 4: Barclays PLC credit risk split by category total and geographic spread, 2011


Geographic Region









Share of total



Share of total



Share of total



Share of total













Loans (w/s and h/l)






















Trading portfolio











Off balance sheet






















Total exposure











of which net exposure


Source: Barclays 20-F.

Note: Net exposure relates to exposure with no net counterparty. Abbreviations w/s refers to wholesale and h/l refers to home loans.

(50) No doubt, Barclays’ management would argue that the relevant measure of credit risk is net risk, which at £794 trilion is still roughly half the size of British GDP. But that net calculation assumes that all Barclays counterparties would or could pay up when things go wrong. And the reliability of this calculation depends on the quality of Barclays internal risk models, and whether there is a systemic crisis where the illiquid and insolvent can’t pay. As we argued some months ago, in a separate publication, the euro zone crisis is a banking crisis about long chain interconnections through bank lending and derivatives from South to North Europe; against this background it is unwise to assume that currently sound counterparties in Northern Europe would pay up in crisis because they are likely to have problems about liquidity and solvency arising from Southern exposures which (in areas like derivatives) are completely unknown to outside parties. Barclays’ pile of assets is not in the interests of shareholders and may cost the British taxpayer dear in a further round of bank re-capitalisations.

(51) The accounting evidence is not conclusive but it is strongly suggestive of the second undisclosed element in the business model. The big pile of low return assets in investment banking is an indicator of firm capture and looting by senior executives because it is likely to inflate their salaries through the connection to turnover (which represents nothing more than a promise of profit for shareholders). How else do we understand the accounting numbers? If we make the comparison with retail, investment banking makes a modest contribution to the bank’s total profitability and trails in its ability to generate ROE. At the same time investment banking requires a large pile of assets to make this contribution (which incurs massive potential liabilities). Whose purpose does the BarCap investment business serve if it needs to ramp assets to generate a modest return? Is it not paradoxical that those senior employees who are paid most within Barclays investment banking division are unable to turn a higher profit on the assets they manage? If banks are making some contribution to efficient capital allocation, why are the highest paid the worst performers in terms of allocative results. Are they not looting the company?

(52) The third, absent, element in the business model is any consideration of the social interest. While private shareholders do get modest returns, the citizen who back stops the risk when it all goes wrong gets almost nothing out of an investment bank like Barclays - either directly in the form of taxes paid or indirectly in the form of banking products which are fit for purpose or in the form of loans that support the productive economy. British citizens could and should ask Barclays management, what have you done for us lately?

(53) If we look at Barclays profits or pay, the totals run into billions. This machine for enriching elite investment bankers paid out 46% of BarCap turnover in comp last year when the whole bank’s headline ( adjusted" profit was more than £5billion. But tax payments can be measured in hundreds of millions because Barclays is a corporation built on tax avoidance. The risks to the tax payer are not offset by corporation tax because Barclays has used losses to minimise its payments; a parliamentary question in early 2011 forced disclosure that Barclays paid just £113 million in UK corporation tax in 2009. Again, this is not matter of standard private sector practice because there is clearly a line between Barclays’ aggressive tax avoidance and the practice of socially responsible private PLCs (like supermarkets, Tesco and Sainsbury) which pay around 25% of profits in taxation.

(54) Ordinary bank customers are equally right to be aggrieved about a sector which has repeatedly sold retail products which are not fit for purpose as it has admitted in successive scandals about mis-selling of endowment mortgages, personal pensions and payment protection where Barclays alone has now made £1.3 bilion provision against claims of mis-selling.. This serial misbehaviour is what happens when the demand for shareholder value returns intersects with confusion pricing and selling to retail customers. Retail delivers 15% returns on equity because the high street retail business model is to cover free current accounts and expensive high street branches with aggressive cross selling, where fines and claims are an acceptable cost of business

(55) Nor is there indirect social benefit through loans for the productive economy. Barclays’ pile of assets continues to do very little for the UK’s productive economy because of the continuing bias in its lending patterns. As table 5 shows, more than 60% of Barclays company-wide lending and of Barclays UK lending is to other financials and for house mortgages, and the sums advanced to other financials and on mortgages have increased sharply since 2007. If we consider loans to manufacturing, retail and wholesale distribution sectors, they account for no more than 7.2 % of the UK loan book in 2011 and these loans are in relative and in nominal terms sharply down on 2007 levels (see also figures 1 and 2). The company’s explanation is that there is not much demand for loans to the productive economy and that may be true. But that does not explain Barclays’ business model which involves an investment banking commitment to low-return assets in the hope of higher ROE, with the taxpayer footing the bill when it all goes wrong.

Table 5: Barclays PLC lending to UK customers, 2007 and 2011 (Nominal data as reported by Barclays during the financial year)



Nominal increase/ decrease 2007-2011






























Energy and water






Wholesale and retail business






Other business






Home loans






Cards and other personal loans












Net lending






Of which:

Total non-finance business (excl. property)






Source: Barclays PLC annual reports

Note: Non-finance business is manufacturing, construction, energy and water, wholesale and retail business, other business.

Figure 1: Barclays PLC UK lending 2007 and 2011 split by sector

Figure 2: Barclays PLC UK lending to the non-financial sector, 2007 and 2011

(56) The problem of ‘banking culture’ is thus materially embedded in the bank’s business model so that the madness of Barclays is mandated by the model which supports the socially dysfunctional behaviours that concern us. And, in turn, reform is complicated because the business model is not so much technically mis-regulated as politically sponsored by elites.

(v) (Political) authority to spoil the business model

(57) In focusing on Barclays we are not suggesting that they are a ‘bad apple’ in the system. We have focused on that bank because it epitomises the wider systemic problem. The ‘cultural’ problems of banking arise from the very character of the business models which now dominate investment and retail banking. This means that reform is no easy matter because effective reform demands changes in more than firm level governance, attitudes, and in regulatory practices. Therefore, addressing the problem of the business model is beyond the authority, or the will, of bankers and their regulators. Reform of the investment banking business model depends on the exercise of the political authority which democratic legitimacy confers on legislators. Thus the political courage shown by this Parliamentary Commission will be critical to the future. Change demands an act of courage on the scale of the great Glass-Steagall reforms in the United States in the 1930s, reforms which stabilised the American banking system for a generation. One issue for members of the Commission is whether they have the political courage of legislators like Senator Carter Glass and Representative Henry Steagall.

(58) They will need this courage because the obstacles to reform do not just lie in the structure of banks; they also lie in the institutions of democratic government – in the executive, in the parties and indeed in Parliament. The Libor scandal provided opportunities for the kind of adversarial blame shifting for which the House of Commons has now become a byword. The finances of the parties also provide plenty of opportunities for adversarial exchanges. It has been well documented, for instance, that under David Cameron the proportion of Conservative Party funding derived from the City rose by 25% in five years to make up 50.8% of the Party’s total – 27% of this came from hedge funds and private equity. And, in a kind of parallel to the contrition of bankers, front benchers of both main parties have acknowledged that they got too close to the City in recent years. [1]

(59) But the problem of political authority over the City goes beyond a matter of individual contrition, and this explains why there are such great obstacles to the exercise of democratic authority for the purpose of fundamental reform. The City has acquired a uniquely powerful position in British society and radical reform will involve confronting that power. The observation that the financial markets, and the interests embodied in them, are powerful in shaping economic policy in the UK is hardly novel. But the striking development of recent decades has been the reconfiguration of the institutional mechanisms that convert this economic muscle into influence over policy. Three active forces are at work: the reorganisation and professionalization of the lobbying capacities of London finance; the changing institutional configuration within the core executive, notably the way this has affected the capacity of financial interests to make their voices heard at the heart of government; and the changing relationship between democratic actors, especially the major political parties, and City interests.

(60) For much of the twentieth century the City was barely recognisable as a ‘lobby’; its considerable influence over policy depended on social and cultural integration with governing elites, and on the Bank of England as a mediator between City interests and the core executive. The development of more open and transparent systems of interest representation, and the growing relative autonomy of the Bank of England from City interests, made this informal regime of representation increasingly anachronistic. The financial elite responded with professionalization and more formal organisation of its lobbying operations. Aeron Davis has documented the rapid growth of professional financial PR and lobbying services in the City in recent years. Under Angela Knight, a Treasury Minister in the Major governments of 1990-7, the British Bankers Association was revitalised as a lobbying operation: it had originally been revived to speak as the voice of British banking in Brussels, but now acquired a prominent role in domestic lobbying.

(61) A second big change has involved the role of the Corporation of the City of London. Until near the end of the 20th century it was largely a body with narrow local government and social functions. Now it has been reorganised into a systematic lobby for London finance. A key change occurred in 2002, when the constitution of the Corporation was reformed: it had hitherto escaped every reforming measure in local government since the original Municipal Corporation Act of 1835. The City of London Ward Elections (2002) does something unique in British local government. The business vote in all other local government systems of the UK had finally been abolished in 1969. The Act of 2002 not only retained the business vote in the City, but greatly expanded the range of the business franchise, so that business vote now actually outnumbers the residential vote in the City. The Corporation has applied its considerable historical endowments to building up its advocacy and economic intelligence capacities: it was the Corporation, for example, which provided much of the research work for the Bischoff Report.

(62) Within the Executive the powerful role of City interests is well illustrated by the case of United Kingdom Financial Investments (UKFI) which, as members of the Commission will well know, is the vehicle for managing the huge tranche of the banking system acquired in the rescue operation after 2007. UKFI was from the beginning defined by its founding chief executive (John Kingman, then a senior Treasury official) as an ‘arm’s length’ institution: that is, an institution operating at arm’s length from the democratic state. Its relations with the ‘city state’ were very different – and much closer. Its successive chairmen have been City grandees, and its senior executives have been drawn overwhelmingly from the financial elite. Moreover, its operating strategy has been defined in a familiar, pre-crisis language of the maximisation of shareholder value: it sees itself as promoting any practices in the banks - including the highly contentious bonus system – that will allow it eventually to dispose of its holdings on terms which maximise return to the taxpayers as shareholders.

(63) The nexus between the core executive and the elite of the city state has been in turn strengthened by the third force: the rise of a financial nexus between the leading parties and City interests. The figures cited above about the Conservative Party’s present reliance on City money are the common material of adversarial party exchanges. But they are only significant because they illustrate a deeper set of problems: both major parties in office are magnets for City money; and in office both welcome the money because the financially independent mass party which flourished a generation ago is now a thing of the past.

(64) Pinto-Duschinsky’s landmark study of party finance shows that in the golden age of the mass party the Conservatives, contrary to many myths, raised most of their income through membership dues and fund raising activities at local level. [2] . The bulk of income came from the constituency parties – large in the age of the mass party - and highly effective fund raising operations. There were some obvious and unsurprising social and geographical biases in constituency party strength. But in the age of the mass party – at its post war peak the Conservative Party had 2.8 million members – both membership and fund raising had a wide base: the Party had large, wealthy constituency organisations in Scotland and the north of England. It thus had deep social roots, and funding sources, outside the metropolitan centre. These roots have now withered: there are presently about 200,000 individual members, most of them elderly; Labour has about 170,000. (At its peak there were more Young Conservatives than there are now members of the whole Party). These withered social roots have also had an important financial consequence: the Party in the country is no longer a significant source of income.

(65) Moreover, increasing transparency about donations –beginning with the 1967 Companies Act and culminating in the regulatory regime now run by the Electoral Commission – has made large corporations hesitant to donate. The Party has to rely heavily on rich individual backers. A large proportion of this money comes from the working rich created by the financial services revolution – high net worth individuals who have the means to make significant donations, and who as individuals do not feel constrained by the delicacies that hem in major corporations.

(66) We stress that in using illustrations from the Conservative Party we are not seeking to make a partisan point. Were the problem confined to the Conservatives, the problem would be easily amenable to solution by means of democratic electoral competition. But all the major parties have suffered a catastrophic decay of their non-metropolitan roots. The result is not only financial dependence, but a kind of intellectual dependence. It helps explain the enchantment with the City as the source of dynamism in the economy, and the obsession with ‘light touch’ regulation which united both front benches for many years. And since the institutional decay which gave rise to this state of affairs still exists, changing the mindset which produced the moral and financial catastrophe in British investment banking is going to be extremely difficult. Hence the need for conspicuous courage on the part of the Commission when it produces its report.

(vi) Recommendations

(67) If the political will and authority exists, it is possible to make recommendations that will change the economic practices and business models that now dominate the banking industry and thereby transform culture and behaviour which depend on material support and encouragement. Indeed, the good news is that, if the political will can be summoned, the reform policies already advocated by radical critics of banking could be deployed purposively to spoil the business model. We will below summarise some major recommendations and in each case end by explaining how it spoils the business model. If the political will does not exist, then we will get governance reform at firm level and (maybe) some kind of macro prudential regulation which will not change bank behaviour and outcomes for the taxpayer.

(68) The first recommendations are about segregating and shrinking the investment banking sector and forcing a change in the business model by limiting senior management ability to loot.

(69) i. Segregate investment banking (by completely separating retail and investment banks) so as to remove the possibility of cross subsidy from retail and expose the risk and returns characteristics of investment banking. After the Libor scandal, the Vickers proposal to establish ring-fences or ‘Chinese walls’ between retail and investment divisions looks less adequate than ever. Allowing the two activities to remain together serves nobody bar the bank executives who benefit from opacity and cross subsidy. A growing number of people – most recently Lord Myners and Lord Lamont – are now calling for a complete split, and this stands as the most simple and most politically attainable of the banking reforms proposed. Here is where the Commission could, through structural reform recommendations, most clearly emulate the courage of Senator Glass and Representative Steagall’s original foundation of banking probity and stability in the American New Deal.

(70) ii. Assert the public interest by announcing the policy objective of a smaller investment banking sector. Contrary to the PR story repeatedly told by the City, the social contribution of investment banking to the UK economy is, in light of the risks it creates, either negligible or negative – an observation documented in our own research publications, and made with particular force in the reflections on the crisis by Andrew Haldane and Adair Turner. Bank assets worth several times the value of UK GDP represent a threat to the UK taxpayer which should not be sustained into the future. Since these risks were exposed by the 2008 crash, proposals for how to minimise them have revolved around either strengthening regulators or making the regulation more complex. Most notably, the Coalition has given the Bank of England responsibility for the FSA’s supervisory duties, under the assumption that a greater concentration of regulatory power will create greater levels of efficiency in spotting and acting upon systemic risks as compared to the previous tripartite system. However, the size, complexity and opacity of the modern banking system – particularly its shadow and offshore aspects – have made modern finance near ungovernable. Given the pace of financial innovation, new pieces of regulation are likely to act only as inputs to an on-going process of bricolage or opportunistic improvisation – just as the increase in Basel II capital requirements led to an expansion of banks’ off balance sheet activities.

(71) iii. Re-engineer pay so as to limit high pay for investment bankers and break the link between pay and turnover. That the working rich of the banking sector are encouraged to misbehave by their incentive structures has become accepted as common sense. And yet widespread public anger has been misdirected because, while the form of bonuses has been changed, little has been done to restrict the size of those bonuses, and nothing has been done about pay and its connection to turnover. Even the timid reforms proffered in 2009/10, concerned with deferring payment or reducing the proportion given in cash, have been circumvented. Government cannot rely simply on episodes such as the ‘shareholder spring’. It must use its authority to intervene for the public good. The most simple and effective action would be a large tax on firms’compensation funds. More significant and less acknowledged than bonuses (as a form of pay) are the use of compensation ratios (to determine the size of the pay pot) so that senior investment bankers expect a share of net revenues. This form of pay is one of the main drivers of the ‘looting’ which we earlier analysed. Restricting compensation ratios by taxing the compensation (pay) fund is therefore an obvious step to both re-engineer incentives and reduce the size of investment banking.

(72) iv. Levy a financial transactions tax because that is a way of discouraging long transaction chains (with the booking of profit on day one) which are part of the socially pointless churn and clip central to the present business model. The object of reform should be to diminish socially useless speculative activity and leave behind a smaller but more effective system which acts as the servant of industry and wider society rather than the master. This would be best achieved not by shutting down trading operations directly but by frustrating the modus operandi. A variety of measures can be brought to bear to reduce the volume of financial transactions taking place, but most immediately feasible would be a financial transactions tax – for which there is already substantial public support.

(73) v. Restrict the use of secrecy jurisdictions. As authors like Nicholas Shaxson have demonstrated, secrecy jurisdictions are not so much an adjunct to the modern financial system as an integral part of it, enabling banks to dodge taxation and keep their most risky activities hidden from regulators . [3] In the aftermath of the 2008 crash, world leaders led by Barack Obama produced a flurry of promises to clampdown on the banks’ use of secrecy jurisdictions. So far little has been done. The City of London and its offshoots in the British island protectorates remains the most significant secrecy jurisdiction in the world, and pressure for change should begin in the UK.

(74) vi. End ultra-loose monetary policy which sustains an on-going bank welfare regime (now perniciously combined with tight fiscal policy that harms the real economy). The Bank of England’s provision of abundant liquidity for the banking system, through more than £300 billion of quantitative easing plus unprecedented low interest rates, is effectively bank welfare because it provides cheap feedstock for speculative activity like carry trades, and thereby diminishes the impetus for more serious reforms. Tight fiscal policy meanwhile has sucked demand out of the economy and thereby lowered the appeal for the banks of productive lending. The government needs to create more accommodating macro-economic conditions as a context for banking reform but with strict controls on property lending which was the Achilles heel of deregulated finance under Thatcher and Blair.

(75) Changes of ownership in themselves achieve nothing if the business model stays the same, but will deliver much if combined with an attack on existing business models. This leads to our second series of recommendations which concern ownership

(76) vii. Compel new non PLC ownership models in banking that remove the illusions of shareholder value which have been used to legitimate ramping assets in wholesale and incentivised mis-selling on the high street (at the same time as it prevents us from coming to terms with how we manage a low return and high investment economy). The high returns targets demanded by PLC shareholders and continual stock market pressures provide an incentive for banks to engage in risky or corrupt practices and provide cover for looting by managers (which is always legitimated as in the interests of shareholders). Given retail banking’s role as a public utility and the experience of repeated mis-selling, PLC ownership should be restricted in retail banking, with moves towards mutual ownership and regionalisation encouraged in order to ensure that banks serve the interests of their customers first and also pay attention to the general good.

(77) viii. Break up too-big-to-fail-banks. The high level of concentration in retail banking creates institutions that are, to use the popular phrase which emerged in 2008, too-big-to-fail. We achieve nothing just by breaking up the banks and creating a larger number of smaller institutions with the same business model. But we do need smaller banks with new business models. We agree with the Governor of the Bank of England that if a bank is too big to fail, it is simply too big. One implication is that retail oligopolies need to be broken up. Another is that this breakup might be arranged along regional lines, as a public policy measure to counteract the metropolitan bias of the wider economy.

(78) ix. Make the nationalised banks behave like public banks which exemplify a new engagement with the public economy. The taxpayer has ploughed enormous sums of money into rescuing the banking system. Northern Rock, RBS and Lloyds TSB, have received direct bailouts, but all banks have benefited from other forms of public subsidy, in particular Quantitative Easing (QE) and deposit guarantees. Public support has not, however translated into banks acting in the public interest. The taxpayers’ stake in the part-nationalised banks has been managed with ‘arms-length’ technocratic detachment by UKFI, which has ensured minimal disruption to the banks’ existing priorities and practices and sought a return to business as usual as quickly as possible (even if, in the case of Northern Rock/Virgin Money, it means that the taxpayers have taken a substantial loss on their investment). Generously low Project Merlin lending targets were barely reached by the major banks, and there is a need for more targeted, socially useful investment to help stimulate the UK economy. The public stake in RBS should be used to transform the institution into a state-backed industrial bank, and the other major banks should have non-voluntary targets for productive lending set by government.

(79) Overall, we should recognise that more and better governance (within the existing PLC framework of NEDs drawn from the officer class) will achieve very little. A diversity of corporate forms should broaden the range of civil society interests represented. But the approach to reform needs to be much more political, as the next recommendation outlines, and the first priority should be to limit the influence of London finance over the political system which has so far prevented serious reform.

(80) x. Democratise finance. The crisis of the banks is a crisis of politics and the democratic disconnects which allow finance to work against the common good. The re-democratisation of finance will require many measures. First a number of overtly political measures are needed. These include: greater transparency and restrictions around lobbying to avoid the capture of regulators and politicians; the transformation of the City of London into a public organisation, instead of being an anomalous territorial-state preserve of finance; reforms to the funding of political parties in the hope that they can rebuild themselves with a mass membership of citizens rather than reflecting the concerns of a small elite of wealthy backers. These political interventions need to be paralleled with measures that will reduce the ability of special interests to capture knowledge and expertise, since it is only with the democratisation of knowledge that it will become possible to scrutinise the operations of finance and render these accountable. Once again the potential list of interventions is long. It might start by handing greater power to Select Committees (already one of the more significant locations of financial scrutiny), for instance by introducing expert cross-examiners (as has been so effective in the extra parliamentary Leveson inquiry); by creating independent institutions and locations for cross-examining the operation of systemically significant financial institutions, supported by expert counsel, but also by an informed but heterogeneous membership drawn from sectors other than finance; by extending the freedom of information act to cover systemically important financial institutions; and by creating appropriately funded public research institutions with the remit to produce pluralist and dissenting forms of expertise and knowledge about finance.

(81) When all this has been done, there would still be a residual problem of culture in banking As Bob Diamond and others show, when bankers respond to criticism, they simply do not get it, cannot take responsibility for their actions and are full of excuses. It is not easy to deal with these forms of denial and the response needs to be inventive.

(82) xi. Complicate affiliations. The need to re-engineer incentives returns us to the issue of culture. A dose of fear might help - by which we mean fear of penalties. While institutional changes to regulation are not a magic bullet for reform, we do need better resourced and more adversarial public regulators. Conversely, as well as a dose of fear, the right kinds of rewards would help. Present incentives tend to work in terms of an individual calculus, whereas it is the very culture of individualism that needs to be undone. Our suggestion, then, is that we need mechanisms for complicating affiliations so that those in power are bound to people unlike themselves. National Service worked this way. (No, we are not recommending a return to National Service, but it is notable that the one-nation Toryism of, say, a Harold Macmillan was born in the trenches). Certain kinds of collectivities (think of the NHS) work in this way for those – most of the population of the UK – who use them. Our argument, then, is that alongside the macro-politics we also need micro-structural interventions to complicate the affiliations of people such as traders. Here is one modest suggestion: that people in elite positions should spend two weeks a year working on the shop-floor, or its equivalent. (If we were after long-term affiliations, then it would be the same shop floor, year after year.) Or (this is done in some companies) they should donate substantial amounts of time to working within an NGO or a voluntary association. This is just a sample of small suggestions. The larger point is that we need many small-scale forms of structural re-engineering if we are to create new mechanisms for weaving complicating social affiliations. 

23 August 2012

[1] Correspondence to: or

[1] The authors of this submission are affiliates of the ESRC funded Centre for Research on Socio-Cultural Change at the University of Manchester and the Open University. We gratefully acknowledge the financial support of the Economic and Social Research Council but the views and positions in this submission are of course those of the authors, who have for several years worked together as a collective on financial crisis and economic reform. This submission is freshly prepared, presents new evidence and develops previous arguments but draws on many years of collaborative work, most notably a book by E. Engelen et al . After the Great Complacence: Financial Crisis and the Politics of Reform (Oxford University Press, 2011).

[1] Statement by Barclays issued 27 th June 2012

[2] BoE governor urges reform of Libor, Financial Times , 29 June 2012,

[3] ‘Ministers to order Libor bank rate review’, BBC News , 30 June 2012,


[4] ‘Ministers to order Libor bank review’, BBC News , 30 June 2012,

[5] ‘Anthony Salz to lead independent business practices review’ at

[6] ‘Shaming the banks into better ways’, Editorial, Financial Times, 29 June 2012, .

[7] Barclays Annual Report & Accounts, year ending 2011, p234

[8] G. Akerlof and P. Romer. Looting: the economic underworld of banking for profit. Washington: Brookings Papers on Economic Activity . Washington: 1993.

[1] ‘Tory Party funding from City doubles under Cameron’, The Bureau of Investigative Journalism , 8 February, 2011, , ‘Hedge funds, financiers and private equity make up 27% of Tory funding’, The Bureau of Investigative Journalism , 30 September 2011,


[2] M. Pinto-Duschinsky, British Political Finance, 1830-1980. Washington: American Enterprise Institute.


[3] N. Shaxson, Treasure Islands: tax havens and the men who stole the world. London: Bodley Head 2011.

Prepared 22nd September 2012