Changing banking for good - Parliamentary Commission on Banking Standards Contents


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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© Parliamentary copyright 2013
Prepared 19 June 2013