Banking Standards

Submission from Global Witness (S017)

· Global Witness is a non-governmental organisation based in London that seeks to break the links between natural resources, corruption and conflict. Co-nominated for the Nobel Peace Prize for our work on conflict diamonds, we use exposé investigative reports to campaign for change in behaviour, policy and laws. Our investigations have shown how a poor culture of compliance within the banking industry and weak regulation has allowed corrupt politicians to access the financial system.

· The problems that we have documented are part of a broader pattern of compliance failures within the industry that has led to a litany of scandals including sanctions busting, the rigging of LIBOR and massive unauthorised trading.

· In our view these problems are a result of poor professional standards and culture within the banking industry, where profit all too often trumps obeying the rules. The compliance function is often sidelined and can have little real authority or independence. This problem is compounded by a remuneration structure that does not do enough to reward staff members for being "compliant" with the relevant rules and professional standards.

· Misbehaviour by banks often goes unpunished by supervisors and prosecutors, whereas individual bankers stand to make enormous personal gains from striking deals with unsavoury customers.

Corruption and the financial system

1. Given the scale of global corruption [1] it is not possible for corrupt officials to just deal in cash. They need a bank to hold accounts, make transfers and allow them to spend their illicitly-acquired funds. Grand corruption is simply not possible without access to the banking system. Banks that do business with corrupt politicians are therefore facilitating corruption, which deprives some of the poorest people of the world of much needed funds for development.

2. Global Witness’ work has shown how time and time again major international banks have been willing to do business with corrupt customers. HSBC took money from corrupt Nigerians, Deutsche Bank held accounts controlled by a Central Asian dictator and Barclays allowed the notorious son of the President of Equatorial Guinea buy a sports car and €18m of artwork despite his modest government salary. [2]

3. There is a global anti-money laundering regime that requires banks to carry out checks on their customers and report any suspicious activity to the authorities. But our research suggests that this compliance framework is failing to prevent corrupt politicians, and other money launderers, accessing the financial system.

Poor culture of compliance

4. In June 2011 the Financial Services Authority (FSA) published the results of a thematic review into how banks in the UK handle high money laundering risk customers, in particular where there is a risk of corruption. [3] The results provided a shocking insight into how many bankers view compliance: if the risk of getting caught is low, they are prepared to take suspect business. The FSA found that "a third of banks, including the private banking arms of some major banking groups, appeared willing to accept very high levels of money-laundering risk if the immediate reputational and regulatory risk was acceptable". [4] Three-quarters of banks in the FSA’s sample failed to identify the source of wealth and source of income of clients who were senior foreign politicians, despite the fact that this is a clear legal requirement. [5] In conclusion the report said that "three quarters of banks in our sample, including the majority of major banks, are not always managing high-risk customers […] effectively and must do more to ensure they are not used for money laundering". [6]

5. This poor performance was in many cases driven from the top and cannot be dismissed as one or two "bad apples". In nearly half of the banks that the FSA visited it found a poor anti-money laundering compliance culture and an apparent lack of leadership on this issue from senior management. [7]

6. Where banks were worried about the financial crime risk posed by their customers it appears to have been driven by concern for the bank’s reputation, rather than by whether the customer was actually engaged in criminal behaviour. The FSA concluded that "as a result, senior management were willing to take on extremely high-risk customers, including where evidence appeared to point towards the customer being engaged in financial crime, as long as they judged the immediate reputational risk to be low." [8]

7. Some banks also appear to have a poor attitude towards their regulators. In an exceptionally strongly worded order, the New York State Department of Financial Services accused Standard Chartered of being a "rogue institution" which perpetrated a "staggering cover-up" by repeatedly providing false information to the regulators. [9] One of the most concerning aspects of the order was that the regulator felt that the bank had shown "obvious contempt for US banking regulations". [10] As part of its order against Standard Chartered the New York State Department of Financial Services published emails which showed a Standard Chartered executive saying "You f***ing Americans. Who are you to tell us, the rest of the world, that we're not going to deal with Iranians,"perhaps giving an indication of how compliance was viewed in that bank. [11]

8. Since the order was published Standard Chartered has agreed to pay a $340 million civil penalty to settle these charges with the Department of Financial Services, and it is expected that this will be follow by further penalties from other regulators. [12]

9. In a further example of the way some banks view their regulator, the FSA’s head of prudential regulation, Andrew Bailey, recently told the House of Commons Treasury Select Committee that Barclays had a "culture of gaming" the FSA and that in some areas trust had broken down between the bank and the regulator. [13]

Sidelining of compliance within banks

10. Within banks, compliance is seen all too often seen as a cost, rather than a profit centre. Compliance officers that Global Witness have spoken to describe how they often do not feel empowered to challenge the decisions of the business units. In most banks it is the relationship manager, rather than the compliance officer, who has the final say over whether a prospective customer is accepted.

11. In the worst cases compliance officers are actively sidelined or even dismissed for raising concerns. Martin Woods was a London-based compliance officer with the American bank Wachovia (now owned by Wells Fargo). He alerted the authorities to what he suspected was the massive laundering of drug money through the bank. Woods claims that he was pushed out of the bank due to his actions. [14] Wachovia subsequently paid a $160 million settlement for anti-money laundering failures in relation to Mexican drug smuggling. [15]

12. This year, the Senate’s Permanent Subcommittee on Investigations revealed how HSBC systematically failed to implement US anti-money laundering rules. According to the committee’s chair, Senator Levin, the bank had a "pervasively polluted" culture that allowed money launderers, drug dealers and suspected terrorists to move their money through the US financial system. The committee’s report provided details of how HSBC US’s Chief Compliance Officer was dismissed after raising the issue of inadequate antimony laundering resources with the audit committee of the board of directors. [16]

13. Until compliance staff are properly empowered, with an independent reporting line to

the board, nothing will change.

Lack of incentivisation for compliant behaviour

14. As has been widely discussed, one of the biggest barriers to lawful and ethical behaviour in the banking industry is the way in which bank staff are rewarded for their behaviour. At the moment the pay of bankers is almost exclusively linked to their financial performance i.e. how much money they make for their institution, rather than whether their behaviour is compliant with applicable rules and regulations or even in the long term interests of their customers. [17]

15. This was confirmed by the FSA report, which found that: "due to the nature of an RM’s [relationship manager] role, the risk of capture or conflict of interest is high, in particular where they are rewarded for bringing in business or penalised for lost business opportunities". [18] The pressure on relationship managers is to make money

rather than to ensure that a particular deal or customer is compliant.

16. At present incentive structures are not linked strongly enough to how "compliant" a banker is i.e. how well they act in line with the bank’s policies and any relevant regulations. This needs to change.

Poor supervision

17. In Global Witness’ opinion financial regulators, including the FSA, need to get better at identifying compliance failures at the banks they supervise, and ensure that they are fixed. There are numerous examples of where banks have been found to be in breach of the rules, and yet fail to improve their systems. At times regulators have also failed to ensure that problems are resolved.

18. This is not a one off problem. For example, many of the problems that the FSA identified in its 2011 money laundering thematic review were also identified over ten years ago when the FSA carried out a similar exercise in 2001 following the revelation that £1 billion of assets linked to the former military dictator of Nigeria, Sani Abacha, passed through banks in the UK. [19] This begs the question: what was the regulator doing during that period?

19. In 2010 Global Witness published a report – International Thief Thief – that detailed how two corrupt Nigerian politicians had brought millions of pounds through British banks including Barclays, HSBC and NatWest. [20] This April another corrupt Nigerian politician was sentenced in London to thirteen years for fraud and money laundering. He had numerous accounts in the UK, including with Barclays, HSBC and Abbey National. [21] These are many of the same banks that handled Abacha assets. However, as far as Global Witness knows none of these banks have been investigated to see whether they carried out the appropriate anti-money laundering checks on the politicians or their associates. When Global Witness asked these banks what checks they had carried out their customers, they responded by saying that they could not discuss this matter due to client confidentiality, but assured us that they had rigorous controls in place.

20. In the past the FSA has been reluctant to publically name banks that get things wrong. In 2001 the FSA did not publish the names of the banks that had handled Abacha related assets or even the names of the banks that were found to have had significant weaknesses with their internal anti-money laundering controls. It left to the Financial Times and the BBC to name the banks that had taken the former dictator’s assets. [22]

21. This is perhaps in part due to section 348 of the Financial Services and Markets Act (FSMA) which places stringent limits on the disclosure of confidential information by the regulator. [23] Global Witness believes that this section should be amended to allow the FSA to release specific information about a financial institution’s wrong doing if it would have a deterrence effect for others in the sector and would be in the public interest.

22. Under section 166 of FSMA the FSA can require banks to commission a review of an area of activity that is causing the FSA particular concern. In 2011/12 the FSA used this power in 111 cases. However, at the moment these reviews are not made public. [24] Global Witness believes that in the most egregious cases it would be in the public benefit for these reports to be published. This would provide real examples of bad practice and would serve as a deterrent to other banks.

23. Following the FSA’s thematic review, the regulator promised to be tougher on the banks it supervises with a more stringent approach to inspection visits. This was recognised by the Treasury Select Committee report into LIBOR. The Committee welcomed the FSA’s commitment to take a more "judgement-based" approach to supervision that allowed room for greater discretion from the supervisor. However, the Committee also observed that "the FSA has concentrated too much on ensuring narrow rule-based compliance, often leading to the collection of data of little value and to box ticking, and too little on making judgements about what will cause serious problems for consumers and the financial system". [25] This box-ticking approach to regulation needs to change.

24. The Senate report into HSBC painted a damning picture of a bank that despite repeated interventions from its regulator failed to put in place the necessary systems and controls. However, again the HSBC case study points to weak supervision as part of the problem, in addition to a poor culture within the bank. The Senate report criticised HSBC’s US regulator, the Office of the Comptroller of the Currency (OCC). The bank had been warned by its regulator in 2003 that it needed to improve its anti-money laundering systems and yet the bank did not do enough to fix the problems. But neither did the regulator. The Senate report found that the OCC’s "failure for six years to take action to force correction of fundamental problems in [HSBC US’] AML program allowed those problems to fester and worsen". [26]

25. Finally, the order against Standard Chartered said that the bank’s actions were particularly egregious because during the key period the bank had been subject to formal supervisory action in relation to other anti-money laundering compliance failures. [27]

26. Financial regulators, including the FSA, need to be more aggressive and flexible in their approach to supervision. There are some welcome signs that this is happening. The FSA’s newly appointed head of enforcement and financial crime, Tracey McDermott, has made strong statements about what will happen to errant banks: "If firms try to push things to the limit all the time, they should expect no sympathy when they fall over the edge". [28] However, these promises need to be followed by meaningful action against banks that fail to fulfil their legal obligations.

Insufficient deterrence

27. Global Witness believes that at present the risk/reward ratio is skewed when it comes to compliance and financial crime. Banks stand to make (and do make) significant income from failing to properly apply the applicable rules and ethical standards. The downside, however, seems to be fairly small, with fines that may seem large but are often only a fraction of a bank’s profits, and limited personal responsibility from individual bankers. There also appears to be significant reluctance from regulators to take criminal prosecutions against banks or individuals responsible for compliance failures.

28. Under the FSA’s Decision Procedure and Penalties manual the regulator assesses the value of the financial penalty based on a mixture of factors including the harm caused by the misconduct, the need for a deterrent effect and any mitigating factors including whether the firm was cooperative with the FSA. The value of the harm caused is usually assessed by looking at the revenues the firm has made from the particular product line. This element of the penalty is calculated using a percentage of this revenue with a sliding scale to take into account how serious the breach was. However, the top end of the scale is only 20 percent of the revenue a bank has made from its misconduct. [29] This seems to be a very low basis for calculating a financial penalty. This sliding scale should be revised upwards so that if a bank has committed serious breaches of the rules it should lose all the revenue it made from its illegal activity plus be faced with an extra penalty as a deterrence.

29. Following its thematic review into money laundering the FSA has fined three banks and is reportedly investigating a further two. The biggest fine, £8.75m, was levied against Coutts, the private banking arm of Royal Bank of Scotland. However, this represents only a fraction of the group’s 2011 operating profit of £1.9bn.

30. Other penalties have been more substantial. For example, the combined US and UK fine of £290m against Barclays for manipulating the LIBOR rate is certainly high. Even this, however, is only just over a week’s worth of profits for the bank, and the UK portion of the fine represents a mere one percent of profits. [30]

31. The current pattern is for supervisors to agree a settlement with banks that they suspect of breaching the rules, usually accompanied by a hefty financial penalty. This is obviously quicker and cheaper for government authorities. However, it does mean that regulatory breaches are rarely brought to full trial. In the case of major financial

institutions this never happens.

32. This has been criticised by a number of judges who have to sign off on the settlement agreements. For example, US District Judge Emmet Sullivan described a $298m agreement between Barclays and the US Department of Justice over allegations that the bank evaded US sanctions against Cuba, Iran, Libya, Burma and Sudan as a "sweetheart deal". [31] This means that no institution or individual is ever properly held to account, leading to a culture of impunity.

33. In addition, under the current rules any fine that the FSA imposes is used to reduce the annual levy that other banks have to pay. This undermines the deterrence effect of financial penalties. The Chancellor has announced a review into this. [32] Global Witness believes that at the very least a portion of any fine the FSA receives should be ploughed back into supervision and enforcement activities.

34. These settlements and fines are not enough to change behaviour in the long term. Neither are promises from the banks themselves to improve their performance. As the Senate report notes, HSBC has made promises to reform its anti-money laundering systems following the recent revelations, yet the bank made similar promises in 2003 but failed to implement them. [33]


Banks need to take compliance and culture seriously, and find a meaningful way of demonstrating this publically. Shareholders should also see compliance as an important aspect of long term growth for any bank they invest in. In particular, banks should:

· Tie remuneration to how "compliant" a banker is.

· Ensure that there are independent reporting lines to the board for the compliance function.

· Ensure that dealmakers are personally responsible for the deals they strike in the long run and that the bank is in a position to claw back bonuses and share awards if things go wrong.

Secondly, regulators must ensure that the banks that they supervise are compliant with the law and have the appropriate culture in place. In particular, regulators should:

· Carry out regular supervisory visits that include spot checks on customer files.

· Carry out mystery shopping exercises to see how well banks’ compliance procedures work in practice.

· Ensure that wrongdoing is punished with proportionate, but dissuasive sanctions against both individuals and banks. For the worst offences, this should include criminal penalties against individuals and institutions.

· The basis for calculating a financial penalty needs to be revised. The starting point should be that if a bank has committed serious breaches of the rules it should lose all the revenue it made from its illegal activity plus be faced with an extra penalty as a deterrence.

· In the most egregious cases the FSA should publish section 166 reports that it has ordered so as to provide information to financial institutions and others on bank activity that is deemed to be unacceptable.

Finally, there are legislative changes needed to help the FSA carry out its duties:

· The Financial Services Bill should be amended so that at least a portion of any financial penalty issued by the FSA is used to bolster the regulators supervision and enforcement activities.

· Section 348 of the Financial Services and Markets Act 2000 should be amended to allow the FSA to disclose confidential information that it collects during its investigations if it would have a deterrence effect for others in the sector and would be in the public interest.

23 August 2012

[1] It is particularly difficult to estimate the size of illicit financial flows, but a conservative estimate

[1] from the World Bank suggests that $20bn - $40bn is stolen each year from developing countries.

[1] World Bank/UNODC, ‘Stolen Asset Recovery (StAR) Initiative: Challenges, Opportunities, and Action Plan’, June 2007.

[2] Global Witness, International Thief Thief: How British banks are complicit in Nigerian corruption , October 2010; Global Witness, Undue Diligence: How banks do business with corrupt regimes , March

[2] 2009; Global Witness, ‘Barclays account used by dictator’s son to buy €18m of artwork with suspect funds’, 22 June 2011.

[3] FSA, Banks’ management of high money laundering risk situations: How banks deal with high-risk customers (including PEPs), correspondent banking relationships and wire transfers , June 2011.

[4] FSA, p. 4.

[5] FSA, p. 4.

[6] FSA, p. 6.

[7] FSA, p. 32.

[8] FSA, p. 33.

[9] New York State Department of Financial Services, ‘In the Matter of Standard Chartered Bank, New York Branch: Order Pursuant to Banking Law § 39’, 6 August 2012.

[10] Department of Financial Services order, p. 5.

[11] Department of Financial Services order, p. 5.

[12] New York State Department of Financial Services, ‘Statement from Benjamin M. Lawsky, Superintendent of Financial Services, Regarding Standard Chartered Bank’, 14 August 2012.

[13] Treasury Committee, ‘Minutes of Evidence: Oral Evidence Taken Before the Treasury Committee on Monday 16 July 2012’.

[14] Ed Vulliamy, ‘How a big US bank laundered billions from Mexico's murderous drug gangs’ The Observer , 3 April 2011.

[15] Evan Perez and Carrick Mollenkamp, ‘Wachovia Settles Money-Laundering Case’, Wall Street Journal , 18 March 2010.

[16] Permanent Subcommittee on Investigations, US vulnerabilities to money laundering, drugs and terrorist financing: HSBC case study , 17 July 2012, p. 21.

[17] For example see ‘The Kay Review of UK Equity Markets and Long-Term Decision Making’, 23 July 2012.

[18] FSA, p. 31.

[19] FSA, p. 6.

[20] Global Witness, International Thief Thief , October 2010.

[21] Mark Tran, ‘Former Nigeria state governor James Ibori receives 13-year sentence’, The Guardian , 17 April 2012.

[22] FSA, ‘FSA publishes results of money laundering investigation’, 8 March 2001; John Mason and John Willman, ‘City banks “handled dictator’s fortune”, Financial Times , 9 March 2001; Greg Morsbach, ‘”Abacha accounts” to be frozen, BBC, 3 October 2001

[23] Financial Services and Markets Act 2000, Section 348. See also FSA, The Enforcement Guide , 27 July 2012, para. 6.6.

[24] FSA Annual Report 2011/12, p. 211.

[25] House of Commons Treasury Committee, ‘Fixing LIBOR: some preliminary findings: Second Report of Session 2012–13, Volume I,’ 18 August 2012, p. 87.

[26] PSI report, p. 319.

[27] Department of Financial Services order, p. 4.

[28] Jill Treanor, ‘FSA enforcer taking on City's chancers’, The Guardian , 13 August 2012.

[29] FSA, ‘Decision Procedure and Penalties manual,’ section 6.5A: The five steps for penalties imposed on firms.

[30] Treasury Committee, ‘Fixing LIBOR: some preliminary findings: Second Report’, p. 101.

[31] Harry Wilson, ‘ US judge slams Barclays settlement’, The Telegraph , 18 August 2012. American

[31] judges also criticised settlements involving other banks, including Citigroup and Morgan Stanley. Peter

[31] Lattman, ‘Judge in Citigroup Mortgage Settlement Criticizes S.E.C.’s Enforcement’, New York Times , 9

[31] November 2011 and Peter Lattman, ‘Federal Judge Grudgingly Approves Morgan Stanley Price-Fixing

[31] Case’, 7 August 2012.

[32] Hansard, House of Commons Debate, 28 June 2012, c464.

[33] PSI report, p. 9.

Prepared 22nd September 2012