Banking Standards

Submission from London First (S025)

Introduction

London First welcomes this parliamentary commission on banking standards. With the reputation of the banking industry severely damaged by recent events,1 and the expectation that this will not improve significantly in the near future, it is right that this essential part of the UK economy be scrutinised and the changes necessary to restore trust implemented. [1]

Our comments reflect the concerns of London’s diverse business community. London First is a business membership organisation representing over 200 businesses from a range of sectors, including finance, professional services, property, ICT, creative industries, hospitality, retail and education. Our mission is to maintain London’s status as the best city in the world in which to do business. Restoring trust in our banking industry and ensuring the continued success of our world-leading financial services sector is a key part of this.

Why we need to restore the reputation of our banking sector

Banks underpin our way of life

Banking, combined with the wider financial services such as insurance, is core to our way of life. Banking, at a very basic level, leverages activity, enabling individuals and businesses to access funds above and beyond their savings: the ability of an economy to grow is dependent on the availability and price of capital (and the ability to offset certain risks through insurance and related products) and therefore the actions of the banks and the ability of this sector to provide competitive, secure funding streams is an essential driver of growth.

Actions that result in a loss of liquidity to the market or dramatic and unanticipated increases in costs have lasting effects on the economy. Likewise policy responses which reduce the capacity for bank lending or increase the cost of lending beyond that justified by the risk will hinder growth.

At a practical level, the banking system underpins our society by providing the infrastructure that enables individuals and businesses to manage their finances and interact with one another. The fact that many essential services – such as ATMs – are provided free at the point of use to most customers demonstrates the importance of ensuring that the sector remains economically viable.

This is not to suggest that badly run banks should not be allowed to fail. So long as there are adequate measures in place to ensure that, in the event of a bank failure, retail customers’ deposits are protected, then banks should be subject to the same risks as any other commercial activity, with shareholders and creditors bearing any loss.

Banks generate jobs, business and tax revenue

As well as being a facilitator of business, banking is an important sector in its own right. The banking sector currently provides over 140,000 jobs in London and over 420,000 in the UK. In 2011, banks paid approximately £21 billion in direct corporation tax, income tax and national insurance [2] – equivalent to almost two-thirds of the annual cost of the UK’s education budget – as well as indirectly contributing through VAT (which banks are unable to reclaim), property and other taxes. However banking is only part of the financial services industry, an industry that provides the foundation for London’s global city status. The financial services sector as a whole provides over 335,000 jobs in London and contributes £52 billion in GVA. [3]

The economic benefit of London’s financial services cluster extends beyond its direct contribution as it supports a number of other world-leading clusters, most notably professional services. The growth of professional services over the past few years has been significant, and this sector now employs over 300,000 in London alone, yielding £17.7 billion to the Exchequer. Together the banking and professional services sectors employ over two million people in the UK and contribute £175 billion to the UK’s GVA, [4] equivalent to over 13% of the UK’s total GVA. [5] This cluster would be greatly diminished if London no longer housed a concentration of global banks.

London’s financial services cluster supports London’s global city status

A key factor in London’s global city status is its leading financial services sector. A diminution of this would threaten London’s global status which, in turn, would have a wider impact on the London economy. For example, London’s leisure industry is reliant in part on serving high-earning individuals, many of which are employees of the financial and professional services firms. If domestic demand is reduced this could, in turn, lead to a reduction in facilities which in turn would reduce the attractiveness of London to tourists and, indeed, to other businesses.

Desired outcome

While trust clearly needs to be restored to the UK banking industry, the breakdown in trust in the sector has not been confined to this country. [6] Certain aspects of the industry’s rehabilitation therefore needs to be driven by regulations developed at an international level (to ensure stability across this interconnected sector and prevent regulatory arbitrage) but, at a UK level, these need to be complemented by recommendations that support London’s continued position as a global financial centre of excellence and restore its reputation as a business environment built on integrity. As we discuss below, while a return to the days when ‘my word is my bond’ was an acceptable alternative to a legal contract would be an unrealistic aim, a re-establishment of the ethos that underpinned that concept would bring both long-term stability and competitive advantage.

The problem

Incidents that have come to light over recent years have highlighted problems affecting the stability of the banking system, such as the culture operating within some major banking institutions and the behaviour of certain individuals within some banks. [7] While the majority of institutions and bankers played no role in the recent problems, the combination of these events has resulted in a wholesale loss of trust both in banks as institutions and in bankers as competent and trustworthy individuals. The extent of the damage caused by these banking scandals has not been confined to the banking industry but has damaged the reputation of the wider financial services sector and the international perception of the City of London. This wrongdoing must be seen to be dealt with – the perpetrators punished – and actions taken to ensure such behaviour is not repeated either at an individual or institutional level. However, in both acting against wrongdoers and attempting to mitigate future errors, it is important to recognise that we are dealing with a barrel containing some rotten apples rather than the Augean Stables.

While the various banking problems have the common result of a loss of trust, the cause of each has been different. The credit crisis arose from a mis-pricing of risk, specifically sub-prime debt; product mis-selling, such as PPI, was encouraged through short-term incentives, aggressive sales targets and weak internal checks; and the Libor scandal appears (in part) to have arisen from senior level decisions on the manipulation of data to present an enhanced image of the institution.

The problems have also affected different segments of the banking market. As with many industries, banking is not a homogeneous sector: different banks fulfil different roles in the economy, face different risks, pose different threats and operate in different competitive environments. By way of illustration, while attention has focused on a handful of market participants, the UK is home to some 318 authorised banks (of which 241 are foreign banks located in the UK – the vast majority in London) [8] and most have had no involvement in any of the issues that have had an impact on the sector’s reputation.

In developing recommendations, it is important to recognise the heterogeneous nature of the industry and ensure measures are targeted, proportionate and effective.

Measures already in play

Given the long-term nature of this problem (the reputation of the banking sector was severely damaged by the credit crisis five years ago and has not recovered since) there is already a wealth of regulation underway aimed at restoring the stability and trustworthiness of the sector. [9] The fact that there are long lead times for much of this existing reform programme should not be mistaken for inactivity in this space, not least as the markets tend to require action much sooner than the regulatory timetable suggests (for example, increased capital requirements required under Basel III are already being expected and monitored by the markets).

Alongside the regulations developed to deal with the stability of the banking system, measures are also in process to address concerns over customer protection, principally the Retail Distribution Review, which aims to ensure a resilient, effective and attractive retail investment market in which consumers can have confidence when planning their retirement and investments.

We believe that in these areas, regulation already in place (or shortly to be implemented) should be given time to take effect and evaluated before any further measures are considered.

However, a gap does still potentially exist regarding measures to ensure the ethical behaviour of bankers: putting the customers’ interests first and letting the profits follow good service.

Potential solutions

Any recommendations for encouraging and supporting a culture of integrity in banking must recognise and support the positive contribution of the majority of the banking industry while dealing robustly with the rogue elements.

Attempting to drive cultural change through prescriptive regulation is likely to be less effective and sustainable than measures that encourage each institution to find its own means of restoring the trust of its customers. Addressing the issue of culture on a principles basis which can be adopted to reflect the nature, risk and business activities of an institution avoids the risk of unintended and adverse consequences that would arise from a more prescriptive, industry-wide approach.

That said, we should remember that the Financial Services Authority aspired to be a principles-based regulator, rather than one that relied on enforcement as its primary tool. As we move to a new regulatory structure, it is reasonable to expect that a principles-based approach may still need to be supported by certain targeted regulation and a consistent approach to enforcement that visibly penalises (and therefore, should deter) rogue behaviour.

Ensuring a set of principles-based recommendations are effectively enforced and monitored will be difficult. However, increased (and in some cases excessive) public and media scrutiny of this sector could assist in holding banks and bankers to account.

A more ethos-driven culture should incorporate the following three themes:

· Setting the tone from the top

· Increased personal responsibility

· Retail banks operating as service centres rather than shops

Setting the tone from the top

The tone set by senior management is critical in defining the culture of an organisation. This has been recognised in other areas of legislation such as the anti-bribery law. Here, the Ministry of Justice issued official guidance for companies based on six principles, one of which is ‘top level commitment’, comprised of: internal and external communication of the commitment to zero tolerance to bribery, and top-level involvement in bribery prevention.

Establishing a set of values at the top of the organisation whereby business activity is driven, and success measured, not solely on profits but also in terms of customer satisfaction should encourage a culture where serving the customers’ needs is prioritised with the belief that good service will yield returns. While values exert influence over attitudes, and attitudes influence behaviour, studies of corporate culture suggest that it requires more than just a statement of values by senior management to change the culture of an organisation. [10] Ethics and compliance programmes need to translate into an ethical culture throughout the organisation. Research [11] suggests that three actions were particularly important in creating an ethical culture: setting a good example; keeping promises and commitments; and supporting others in adhering to ethics standards.

Making each tier of management accountable for ensuring that its actions reflect the firm’s values and subjecting each to peer review and independent assessment should encourage a positive culture to spread though the organisation.

Increased personal responsibility

Developing a culture of personal responsibility which extends to responsibility of management for those reporting into them would provide a useful internal check on behaviour. Evidence [12] suggests that when companies have an ethos based on self-governance, in which everyone is guided by a set of core principles and values that inspire everyone to align around a company's mission, employees are much more likely to blow the whistle and are more encouraged to put forward new ideas. Within such a culture, there must also be the mechanism for any employee to escalate an issue if it appears to breach the company’s ethos. Whether this is to an individual or, as in some firms, an independent ‘wise men’s’ committee will depend on each particular firm’s structure and style.

Increasing the degree of self-governance within the culture of banking would support a more transparent and constructive employee relationship.

Retail banks operating as service centres

The traditional high street bank used to be a place where advice was trusted and bankers respected. Over the years this image has been eroded as banks have developed a more sales-based approach. This shift has been supported by the incentives provided and targets set for retail bankers. Customers once again need to feel that their needs are the priority and banks need to adopt an approach where good customer service is in itself the priority and profits are driven by successfully and appropriately meeting customers’ needs.

This shift could increase the costs of retail banking which in turn would result in an increase in costs to consumers which would need to be justified by sufficient increases in consumer benefit.

These three suggestions, alongside other ideas that have been mooted, need to be subject to full impact assessments prior to actions being taken. Banking is a subset of the wider financial services industry and the line between banking and other financial services institutions is often difficult to draw. Any regulations aimed at changing the culture of banking are likely to spill over to other financial services organisations and this should be factored into the impact assessments.

Conclusion

Any new regulations or measures designed to restore trust in the banking industry must be considered in light of the regulatory change that is already in process. It is also important to acknowledge that the majority of banks and individual bankers have consistently operated with integrity and they should not be further burdened by measures that will yield no additional benefit to their clients.

In identifying solutions, it is important to understand the problems that have caused the reputational damage, the drivers of these and the extent to which they are endemic to the industry or limited to a few individuals. In developing solutions, the unique nature of banking, its role in the wider economy and society, and its influence on growth must be taken into consideration. In implementing proposals, it must be clear how these will be targeted at the problems and how the risk of regulatory spread (across the financial services industry and beyond) will be prevented or managed.

28 August 2012