Summary
Our approach
The UK banking sector's ability both to perform its
crucial role in support of the real economy and to maintain international
pre-eminence has been eroded by a profound loss of trust born
of profound lapses in banking standards. The Commission makes
proposals to enable trust to be restored in banking. These proposals
have five themes:
- making individual responsibility in banking a
reality, especially at the most senior levels;
- reforming governance within banks to reinforce
each bank's responsibility for its own safety and soundness and
for the maintenance of standards;
- creating better functioning and more diverse
banking markets in order to empower consumers and provide greater
discipline on banks to raise standards;
- reinforcing the responsibilities of regulators
in the exercise of judgement in deploying their current and proposed
new powers; and
- specifying the responsibilities of the Government
and of future Governments and Parliaments.
No single change, however dramatic, will address
the problems of banking standards. Reform across several fronts
is badly needed, and in ways that will endure when memories of
recent crises and scandals fade.
Making individual responsibility a reality
The problem
Too many bankers, especially at the most senior levels,
have operated in an environment with insufficient personal responsibility.
Top bankers dodged accountability for failings on their watch
by claiming ignorance or hiding behind collective decision-making.
They then faced little realistic prospect of financial penalties
or more serious sanctions commensurate with the severity of the
failures with which they were associated. Individual incentives
have not been consistent with high collective standards, often
the opposite.
A new framework for individuals
The Approved Persons Regime has created a largely
illusory impression of regulatory control over individuals, while
meaningful responsibilities were not in practice attributed to
anyone. As a result, there was little realistic prospect of effective
enforcement action, even in many of the most flagrant cases of
failure. The Commission proposes a new framework for individuals
with the following elements:
- a Senior Persons Regime, which would ensure that
the key responsibilities within banks are assigned to specific
individuals, who are made fully and unambiguously aware of those
responsibilities and made to understand that they will be held
to account for how they carry them out;
- a Licensing Regime alongside the Senior Persons
Regime, to apply to other bank staff whose actions or behaviour
could seriously harm the bank, its reputation or its customers;
- the replacement of the Statements of Principles
and the associated codes of practice, which are incomplete and
unclear in their application, with a single set of Banking Standards
Rules to be drawn up by the regulators; these Rules would apply
to both Senior Persons and licensed bank staff and a breach would
constitute grounds for enforcement action by the regulators.
Incentives for better behaviour
Remuneration has incentivised misconduct and excessive
risk-taking, reinforcing a culture where poor standards were often
considered normal. Many bank staff have been paid too much for
doing the wrong things, with bonuses awarded and paid before the
long-term consequences become apparent. The potential rewards
for fleeting short-term success have sometimes been huge, but
the penalties for failure, often manifest only later, have been
much smaller or negligible. Despite recent reforms, many of these
problems persist.
The Commission proposes a radical re-shaping of remuneration
for Senior Persons and licensed bank staff, driven by a new Remuneration
Code, so that incentives and disincentives more closely reflect
the longer run balance between business risks and rewards. The
main features of the redesign are as follows:
- much more remuneration to be deferred and, in
many cases, for much longer periods of up to 10 years;
- more of that deferred remuneration to be in forms
which favour the long-term performance and soundness of the firm,
such as bail-in bonds;
- the avoidance of reliance on narrow measures
of bank profitability in calculating remuneration, with particular
scepticism reserved for return on equity;
- individual claims on outstanding deferred remuneration
to be subject to cancellation in the light of individual or wider
misconduct or a downturn in the performance of the bank or a business
area; and
- powers to enable deferred remuneration to Senior
Persons and licensed individuals, as well as any unvested pension
rights and entitlements associated with loss of office, to be
cancelled in any case in which a bank requires direct taxpayer
support.
A new approach to enforcement against individuals
A more effective sanctions regime against individuals
is essential for the restoration of trust in banking. The current
system is failing: enforcement action against Approved Persons
at senior levels has been unusual despite multiple banking failures.
Regulators have rarely been able to penetrate an accountability
firewall of collective responsibility in firms that prevents actions
against individuals. The patchy scope of the Approved Persons
Regime, which has left people, including many involved in the
Libor scandal, beyond effective enforcement.
The Commission envisages a new approach to sanctions
and enforcement against individuals:
- all key responsibilities within a bank must be
assigned to a specific, senior individual. Even when responsibilities
are delegated, or subject to collective decision making, that
responsibility will remain with the designated individual;
- the attribution of individual responsibility
will, for the first time, provide for the full use of the range
of civil powers that regulators already have to sanction individuals.
These include fines, restrictions on responsibilities and a ban
from the industry;
- the scope of the new licensing regime will ensure
that all those who can do serious harm are subject to the full
range of civil enforcement powers. This is a broader group than
those to whom those powers currently extend;
- in a case of failure leading to successful enforcement
action against a firm, there will be a requirement on relevant
Senior Persons to demonstrate that they took all reasonable steps
to prevent or mitigate the effects of a specified failing. Those
unable to do so would face possible individual enforcement action,
switching the burden of proof away from the regulators; and
- a criminal offence will be established applying
to Senior Persons carrying out their professional responsibilities
in a reckless manner, which may carry a prison sentence; following
a conviction, the remuneration received by an individual during
the period of reckless behaviour should be recoverable through
separate civil proceedings.
Reforming governance to reinforce individual responsibility
The financial crisis, and multiple conduct failures,
have exposed serious flaws in governance. Potemkin villages were
created in firms, giving the appearance of effective control and
oversight without the reality. Non-executive directors lacked
the capacity or incentives to challenge the executives. Sometimes
those executives with the greatest insight into risks being added
to balance sheets were cut off from decision-makers at board level
or lacked the necessary status to speak up. Poor governance and
controls are illustrated by the rarity of whistle-blowing, either
within or beyond the firm, even where, such as in the case of
Libor manipulation, prolonged and blatant misconduct has been
evident. The Commission makes the following recommendations for
improvement:
- individual and direct lines of access and accountability
to the board for the heads of the risk, compliance and internal
audit functions and much greater levels of protection for their
independence;
- personal responsibility for each individual director
for the safety and soundness of the firm and a Government consultation
on amending the Companies Act to prioritise financial safety over
shareholder interests in the case of banks;
- direct personal responsibility on the Chairman
to ensure the effective operation of the board, including effective
challenge by non-executives, and on the Senior Independent Director,
supported by the regulator, to ensure that the Chairman fulfils
this role; and
- individual responsibility for a named non-executive
director, usually the Chairman, to oversee fair and effective
whistle-blowing procedures, and to be held accountable when an
individual suffers detriment in consequence of blowing the whistle.
Better functioning markets
The UK banking sector is not as competitive as it
should be. Retail and business customers alike are often denied
sufficient choice or access to enough information to exercise
effective judgement. Greater market discipline can help address
the resulting consumer detriment and lapses in standards, and
buttress regulation. Where such remedies can be found they should
be deployed. The Commission proposes that:
- the Government immediately establish an independent
panel of experts to assess means of enabling much greater personal
bank account portability;
- the Treasury examine the tax treatment of peer-to-peer
lending and crowdfunding firms to ensure a level playing field
with established competitors and review the effectiveness of tax
incentives intended to encourage investment in Community Development
Finance Institutions;
- the major banks come to a voluntary agreement
on minimum standards for the provision of basic bank accounts,
including access to the payments system and money management services,
and free use of the ATM network, within 12 months or be subject
to a new statutory duty;
- competition be an objective of the PRA, subject
to its overriding responsibility for financial stability;
- the Competition and Markets Authority immediately
commence a full market study of competition in the retail and
SME banking sectors to be completed on a timetable consistent
with a Market Investigation Reference by the end of 2015; and
- the Government should immediately announce a
process for considering alternative strategies for the future
of RBS, including splitting the bank and putting its bad assets
in a separate legal entity (a 'good bank / bad bank' split), to
report by September 2013.
Reinforcing the responsibilities of the regulators
Serious regulatory failure has contributed to the
failings in banking standards. The misjudgement of the risks in
the pre-crisis period was reinforced by a regulatory approach
focused on detailed rules and process which all but guaranteed
that the big risks would be missed. Scandals relating to mis-selling
by banks were allowed to assume vast proportions, in part because
of the slowness and inadequacy of the regulatory response.
Our proposed emphasis on individual responsibility
within banks needs to be matched by the replacement of mechanical
data collection and box ticking by a much greater emphasis on
the exercise of judgement by the regulators, supported by more
effective oversight and empowerment tools. In particular:
- supervisors need to be close enough, and have
a detailed enough understanding, of businesses to take swift decisions
based on up-to-date information, rather than belated actions with
the benefit of hindsight;
- the most senior regulatory staff should be expected
to use judgement, rather than relying on procedures, and to take
direct personal responsibility for ensuring that their engagement
with individual banks, and the CEO, Chairman and the Board in
particular, is securing the information required best to assess
risk. They should expect to be held accountable, ultimately to
Parliament, for this crucial role;
- a new tool proposed by the Commission, "special
measures", will provide for the deployment of a broader range
of regulatory powers when the FCA and PRA are concerned that systemic
weaknesses of leadership, risk management and control leave a
bank particularly prone to standards failures;
- regulators need to remove obstacles to a more
competitive market in banking, including through steps to support
the development of a more diverse banking market;
- regulators should identify the risks to a judgement-based
approach from overly prescriptive international rule books and
ensure that Parliament is kept fully informed of them; and
- there should be mandatory dialogue between supervisors
and external auditors and a separate set of accounts for regulatory
purposes.
The responsibilities of Governments and Parliaments
There were many players in the development of the
crisis in banking that has unfolded since 2007. The behaviour
of bankers was appalling, but regulators, credit ratings agencies,
auditors, governments, many market observers and many individual
bank customers in their approach to borrowing created pressures
in the same, and wrong, direction. Governments have a particular
responsibility, many of them having been dazzled by the economic
growth and tax revenues promised from the banking sector. Implementing
the recommendations of the Commission would signal a fresh approach.
The current Government's particular priorities must
include:
- taking swift and decisive action to place RBS
in a position where it can make a full contribution to a better
functioning market that, in particular, supports lending to businesses;
- ensuring that changes to regulatory objectives
entrench a change in regulatory approach towards competition;
and
- relinquishing political control over decisions
over the leverage ratio, the single most important tool to deliver
a safer and more secure banking system, which is properly a matter
for regulators.
Future Governments and Parliaments have important
roles in ensuring that reform is sustained. In particular, this
will mean:
- holding regulators more meaningfully to account
for their decisions, while avoiding knee-jerk assumptions either
that regulators are acting as an unnecessary constraint on the
actions of bankers or that regulators are culpable for every standards
failure; and
- resisting the arguments from opponents of reform
who will claim that any further change to banking will represent
an upheaval too far or that risks have been eliminated and "this
time is different".
The banking industry can better serve both its customers
and the needs of the real economy, in a way which will also further
strengthen the position of the UK as the world's leading financial
centre. To enable this to happen, the recommendations of this
Commission must be fully implemented in a coherent manner. They
complement reforms already proposed by Parliament and by the Independent
Commission on Banking. If fully implemented, the proposals of
this Commission's Reports can change banking for good.
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