Changing Banking for Good - Parliamentary Commission on Banking Standards Contents

3  The underlying causes


52. The loss of public trust in banking charted in the last chapter is not the result of the action of a few rogue individuals or the odd dysfunctional bank. It is a collapse of trust on an industrial scale. That prudential and conduct failures have occurred simultaneously across banking is not a coincidence: it is the result of common deficiencies of standards and culture. As Sir Alan Budd told the Commission, conduct failings are "symptoms of the same sort of forces which also produced the [financial] crisis".[106]

53. This chapter examines those underlying causes. They stretch much further than the banks themselves: to poorly functioning and uncompetitive markets, to counter-productive instincts in regulators, to a political culture which reinforced those instincts and to a toothless sanctions regime that has failed to hold to account those who presided over recklessness or wrongdoing.

54. The underlying causes of standards failings are also heavily interlinked. For example, a giant bank that reaps significant financial benefits from the implicit taxpayer guarantee is likely to pursue rapid, leveraged growth and adopt a complex, federal structure, combining highly risky investment banking with essential retail services and deposits. Such organisations offer ample opportunities for those in positions of responsibility to evade accountability for wrongdoing, game the regulatory rule book and convince politicians of their vital importance to the wider good. These combined factors are then used to justify sparing the bank from the rigours of market discipline at the expense of consumers and, all too often when bank failure occurs, taxpayers.

This time is different

55. Crises in banking are probably as old as banking itself. A major banking panic in the Roman Empire was only resolved by a large and interest-free three-year loan from Emperor Tiberius.[107] Documenting this episode in 1910, William Stearns Davis noted parallels with the early twentieth century financial system that apply equally well to that of the twenty-first:

    A narrative like this would have no verisimilitude unless placed in a society extending over seas and continents, with a great internal and foreign commerce, rapid means of communication, complex and vast credit transactions, an elaborate system of banking […].[108]

56. Market abuse by opportunistic speculators has been a feature of financial markets for many centuries. Edward Chancellor charted insider trading and illegal short selling of East India stock back to the early seventeenth century.[109] Emilios Avgouleas argued that the history of market abuse can be explained by misaligned incentives, and that "swindlers are rational utility maximisers, especially where such swindlers are financial market professionals". Individuals, he contends, commit financial misconduct because they calculate that the benefits to them outweigh the costs.[110] Financial booms tend to increase the upsides of misconduct. Michael Bordo referred to a "state of euphoria where investors have difficulty distinguishing sound from unsound prospects and where fraud can be rampant".[111]

57. History is littered with financial market bubbles and their subsequent explosions. In his analysis of the 1929 crash, J.K. Galbraith wrote:

    For protecting people from the cupidity of others and their own, history is highly utilitarian. It sustains memory and serves the same purpose as [the regulator] and is, on the record, more effective.[112]

However, banking history is also replete with examples of failure to learn the lessons of crises. Reinhart and Rogoff argued that "no matter how different the latest financial frenzy or crisis always appears, there are usually remarkable similarities with past experience".[113] Forrest Capie attributed these repeated failings to "the recurring belief that we have finally cracked it".[114]

58. The "irrational exuberance" of the build-up to the financial crisis reads as a lesson in failing to learn the lessons of history. In part this is attributable to the interval between major financial crises. As Christine Downton told us, "financial crises don't often happen immediately one after the other: there tends to be a lag while those people who learnt lessons move out of the industry".[115] Philip Augar wrote:

    The banks had been so successful for so long they believed they were infallible. [...] Financial services practitioners, non-executive directors who sat on their boards and regulators all forgot that liquidity is what keeps markets going. They were blinded by their own genius.[116]

59. The "Quiet Period" from 1934 culminated in a period of unusual macroeconomic stability in much of the developed world from the mid-1980s to 2007, characterised by Ben Bernanke as the "Great Moderation".[117] Gary Gorton has referred to what he saw as "some implicit view economists had that crises were a thing of the past" :

    […] there were no longer financial crises or banking panics. The Great Moderation, however, includes a very short period of history. From a longer historical perspective, banking panics are the norm.[118]

In our First Report we referred to the eminent authorities, including the Bank of England and the IMF, who referred in 2006 to the comforting evidence that the financial system was more resilient than in the past and less vulnerable to shocks.[119] As Lord Turner said to us:

    The classic problem for human institutions and for the design of our regulatory structures and our policy is how do we design against [delusion] in 25 years' time, when [...] we have another: 'This time it's different. This time we're cleverer than the previous generation.' That is the institutional challenge, and we have got to try and embed the intellectual challenge, the counter point of view [...] .[120]

60. One factor helping to explain the false confidence of the 2007-08 pre-crisis period was an emphasis on quantitative analysis. This is not new, either. In 1976, Deirdre McCloskey warned that "forty years of investment in mathematising economics and of disinvestment in historicising economics has made it less acceptable among economists to admit ignorance of mathematics than to admit ignorance of history".[121] Mathematical justifications for claiming the market had been tamed were nothing new. Reinhart and Rogoff cited a 1929 newspaper advertisement in the run-up to that year's financial crash, which suggested that, owing to improvements in statistics, events such as the Mississippi bubble of 1720 had become "but a wretched memory":

    Today, you need not guess.

    History sometimes repeats itself — but not invariably. In 1719 there was practically no way of finding out the facts about the Mississippi venture. How different the position of the investor in 1929!

    Today, it is inexcusable to buy a "bubble" — inexcusable because unnecessary. For now every investor — whether his capital consists of a few thousand or mounts into the millions — has at his disposal facilities for obtaining the facts. Facts which — as far as is humanly possible — eliminate the hazards of speculation and substitute in their place sound principles of investment.[122]

61. The years leading up to the 2007-08 financial crisis were, to an unprecedented degree, characterised by growing faith in the complex modeling and securitisation of risk.[123] Scott Paterson described how this reinforced confidence that "this time was different":

    the math wizards […] had helped tame the market's volatility. Out of the chaos they had created an order through their ever-increasing knowledge of the Truth.

The United States Financial Crisis Inquiry Commission found that "increasing dependence on mathematics let the quants create more complex products and let their managers say, and maybe even believe, that they could better manage those products' risk".[124] Paul Volcker emphasised that regulators were taken in by the wizardry, stating that the roots of the financial crisis were "all tied up in the hubris of financial engineers, but the greater hubris let markets take care of themselves".[125]

62. Another factor explaining the reduced confidence until five years ago was the difficulties of swimming against the tide. John Plender wrote that, because it is "impossible to forecast precisely when any bubble will burst", the credibility of those drawing attention to risk is "easily undermined by accusing them of crying wolf".[126] Raghuram Rajan argued that it was in a wide range of interests to allow the myth that "this time was different" to propagate:

    The problem was not that no one warned about the dangers; it was that those who benefited from an overheated economy - which included a lot of people - had little incentive to listen.[127]

Box 3 shows how a common interest in rising property prices can feature in the development of financial crises. Caprio, Demirgu¨ç-Kunt and Kane found that "crises are caused by perverse incentives that make it worthwhile for politicians, regulators and the private sector to ignore mounting danger signals until it is too late to avoid a widespread meltdown".[128]

Box 3: Banking crises and property booms

Several witnesses drew attention to property booms as a recurring characteristic of banking crises. Charles Goodhart said that a common feature of UK, US and European banking crises had been "property finance, especially bank lending for commercial property, but also mortgage lending for residential property".[129] Andy Haldane concurred that "property all too often is the common denominator of getting things wrong".[130] Lord Turner told us that many banking crises have "extraordinarily common features", of which "too much lending to commercial real estate […] is one of the most common".[131] RBS submitted that "the great majority of financial crises in history have been associated to a considerable extent with housing and real estate lending".[132] Charles Calomiris wrote that "the four countries that suffered the most severe bank failure episodes of the pre-World War I era - Argentina, Australia, Norway, and Italy - had two things in common: […] real estate boom and busts […] and […] unusually large government subsidies for real estate risk taking".[133]

Calomiris argued that, in the US in the years leading to the financial crisis, "numerous housing policies promoted subprime risk taking by financial institutions by subsidising the inexpensive use of leveraged finance in housing". The worst of these, he contended, was requiring government-sponsored enterprises Fannie Mae and Freddie Mac to "commit growing resources to risky subprime loans" in order to "maintain lucrative implicit (now explicit) government guarantees on their debts". He argued that these measures, made ostensibly in the name of affordable housing, were "arguably the single most destructive influence leading up to the crisis".[134] In its recent Report on the 2013 Budget, the Treasury Committee drew attention to concern regarding the parallels between the UK Government's new 'Help to Buy' mortgage guarantee policy and the precursors of the Fannie Mae and Freddie Mac schemes in the US.[135] Patrick Jenkins, banking editor of The Financial Times, wrote that it is "as though the Chancellor has learnt no lessons from the financial crisis itself".[136]

63. Robert Pringle told us that, for all the failures of banking regulators, "the lesson of history seems to be that autonomy leads to reckless irresponsibility if it is not constrained by a moral code and credible external sanctions".[137] An executive of Continental Illinois National Bank, which collapsed in 1984, said in 1980 that they had wanted to "demonstrate that a Midwestern country bank can become the most magnificent force in the banking world".[138] In pursuit of this ambition, Continental Illinois enacted an "aggressive assault" on domestic and international banking markets.[139]

64. The story of Continental Illinois has echoes in the collapse of HBOS. In our Fourth Report, we described how senior HBOS management, emboldened by misplaced confidence in their own abilities, attempted to take a short-cut to becoming a major player in banking by adopting a wildly ambitious growth strategy.[140] A major plank of this growth strategy was the acquisition of risky assets in commercial real estate and related markets which seemingly ignored the down-side risks of such assets. In his account of the collapse of Overend, Gurney & Co in 1866, Geoffrey Elliot noted many parallels with other failures:

    Money messes always start in the same way, when judgement is fuddled by greed, ambition and overweening self-confidence. Then when problems arise, there follows an obstinate refusal to admit mistakes or the imminence of disaster.[141]

65. Charles Calomiris argued that "counter-productive responses to crises", such as the extension of deposit insurance, mortgage guarantee schemes or the erection of barriers to market entry, have acted as "visible subsidies for risk taking". [142] He used the Bank of England's explicit removal, in 1858, of its implicit commitment to convert bills to cash in the event of a panic as "an example of effective learning". [143] The policy was tested in 1866 with the collapse of Overend, Gurney & Co. The Bank of England declined to bail the bank out, a choice which Calomiris argued "credibly established the end of moral hazard" in such circumstances.[144] He concluded that, though banking crises have a long history, they are "not a historical constant" and effective policy can reduce the likelihood of them occurring.[145]

66. Banking history is littered with examples of manipulative conduct driven by misaligned incentives, of bank failures born of reckless, hubristic expansion and of unsustainable asset price bubbles cheered on by a consensus of self-interest or self-delusion. An important lesson of history is that bankers, regulators and politicians alike repeatedly fail to learn the lessons of history: this time, they say, it is different. Had the warnings of past failures been heeded, this Commission may not have been necessary.

67. A commission on banking standards cannot address the causes of the financial cycle which is, in any case, extremely unlikely to be eradicable. Nor should the recommendations of a UK body be expected to correct, or attempt to correct, all that is wrong in a global industry. However, that does not mean that nothing should be done. A great deal can and should be done to reduce the risk of future crises and to raise standards. There is currently a widespread appetite for measures to constrain the misconduct, complacency and recklessness that characterised the last boom and its aftermath. However, measures that are implemented while memories are fresh will be at risk of being weakened once the economic outlook improves, memories fade, and new, innovative and lucrative approaches to global finance emerge.

Incentives to become unmanageable


68. In our First Report we considered some of the reasons why it is difficult to allow banks to be put into insolvency in the same way as most other companies. In summary:

·  Banks provide essential services such as current accounts, overdrafts and the payment system in general on which the rest of the economy relies. Any interruption in these services, no matter how brief, would risk causing widespread damage.

·  Insolvency destroys value. Unlike other corporate insolvencies, when the operating business can often be maintained or sold to maximise value, in the case of a bank, all that can often be done is to liquidate the assets. Combined with the fact that banks are highly leveraged, this can magnify creditor losses, as the realisable value of assets is often very different from their carrying value.

·  Disorderly failure can cause contagion because banks in general are reliant on the confidence of depositors and other creditors to keep operating. Allowing one bank to fail in a disorderly way could spread panic among creditors of other similar institutions and cause a wider financial crisis.[146]

69. The challenges of letting a bank fail become more significant the bigger a bank is and the bigger the proportion of the banking system it accounts for. These challenges are particularly significant in the UK, as a consequence of its large and concentrated banking sector.[147] In written evidence to the Treasury Committee, the incoming Governor of the Bank of England, Mark Carney, wrote:

    It is clear that concentration makes instability more costly. In concentrated systems, individual banks are more likely to be systemic and/or too big to resolve safely.[148]

70. In the years leading up to the financial crisis, a banking system populated by large banks, with no mechanism for allowing them to fail in an orderly way, meant that it was rational for creditors of such banks to believe that they enjoyed what is often referred to as an "implicit guarantee" from the Government. If any large bank did run into trouble, the Government would be expected to step in to keep it running, which would mean continuing to meet any repayment obligations to creditors. The fact that no bank bondholders lost money (the only sector where this was true) only reinforced this belief. Douglas Flint noted how this situation lowered the cost of a bank's borrowing and increased its appetite to take risks:

    the implicit guarantee certainly encouraged those who funded banks on the wholesale side to believe that they were taking less risk than the unsecured nature of their lending represented, and because they were prepared to lend to a greater extent and on finer terms than they might otherwise done, that fund of cheaper money gave a pool of resource to bankers to make money from [...] [T]he leverage of the balance sheets seemed to grow without constraint.[149]

71. The value of this implicit guarantee has been estimated at considerably in excess of £10 billion per annum by the ICB,[150] and at over £50 billion by Andy Haldane.[151] Erkki Liikanen noted how the implicit guarantee allowed banks "to grow very fast, and still the markets thought that you should lend to them cheaply because there was no risk".[152] Sir Mervyn King recounted how, long before the financial crisis, many banks wanted to follow the model of Citigroup, then the biggest bank in the world, which was "expanding, shaving a few basis points off its funding costs by getting bigger and using the 'too big to fail' implicit subsidy to lower its funding costs".[153]

72. The perception of a guarantee also affected the behaviour of bank customers. The Treasury Committee wrote that the guarantee "weakened or even removed any incentive for consumers to monitor for themselves the financial institutions with which they deposit their money".[154] This was even the case for larger organisations who should have had the capacity to make more sophisticated judgements about where they were depositing funds. The Communities and Local Government Committee warned of the "moral hazard inherent in an unconditional, open-ended guarantee of local authorities' investments".[155] When the Icelandic banks collapsed in 2008, UK local authorities together held £954m of deposits with them. In its analysis of this episode, the Audit Commission noted that some English local authorities "continued to invest despite clear warning signs" of bank failure.[156]

73. Sir Mervyn King attributed a wide range of problems in banking to the implicit guarantee:

    In my view, many of the failures of the system [...] stem from the very simple point of having a system that relied, in many ways quite explicitly in the minds of those working in it, on an implicit taxpayer subsidy.[157]

As Professor Forrest Capie put it in evidence to the Commission:

    What sort of policy response could be developed that might improve standards? I believe that starting with a clean slate and making it clear that failure is a distinct possibility - it is everywhere else - and will be tolerated and dealt with. There will be no rescues. There will be a lender of last resort to take care of the payments system but that is it. Banks within the payments system can still fail. The lender of last resort is simply there to provide the liquidity needs of the market as a whole in times of stress. Regulation could then be extremely simple. Transparency could be encouraged but not legislated for. An appropriate resolution regime would help convince the market that a failure would not lead to a major disturbance. Behaviour would surely then change and if that is read as improved standards there could be little objection.[158]

The link between the implicit guarantee and failures in corporate governance, remuneration, competition and regulation are considered later in this chapter and throughout the Report. The Commission's First Report set out how despite numerous existing and planned reforms aimed at reducing the implicit guarantee, their effectiveness in relation to the largest banks remains in doubt.[159] This is considered further in Chapter 4.

74. Large banks still benefit from a significant implicit taxpayer guarantee as a result of their status of being too big to fail and too complex to resolve. The guarantee affords banks access to cheaper credit than would otherwise be available and creates incentives for them to take excessive risks. The guarantee also distorts competition and raises barriers to entry. Success does not depend simply on being prudently run or on serving customers effectively, but on the implicit guarantee. The taxpayer guarantee has a wide range of harmful effects and underpins many of the failings that we identify in ensuing sections.


75. The cheaper funding costs for large banks which arise from the implicit guarantee are one reason that banks have been able and incentivised to grow. The Chancellor referred to "economies of scale" in banking as another explanation for why we have large banks.[160] A simple example of this is the high fixed costs in establishing information technology infrastructure, which can be better absorbed by a large institution. Similarly, there may be economies of scope: large banks may be able to better diversify risk or their product offering.[161] At the 2012 World Economic Forum, the President and CEO of Bank of America, Brian T. Moynihan, argued that global reach meant banks could serve clients better:

    Our power, size, capabilities come from our clients. Why we have to have size and scale is to support people in different economies. We are big because our clients are operating around the world.[162]

Bill Winters told us that scale had been an advantage because the largest banks could "satisfy the largest customers, be they sovereigns or corporations".[163] Mr Winters also explained that regulatory capital requirements rewarded size because of a misguided faith in the apparent diversification of risk.[164]

76. Professor John Kay was largely dismissive of economies of scale in banking:

    I do not have much sympathy for the size argument. There clearly are some economies of scale in banking, but I think they are largely exhausted at a pretty low level. To the extent that they are not exhausted they are mainly on the technological side.[165]

He argued that banks have tended to diversify into areas they have not understood:

    The greatest security you get is from diversification, but it is not from diversification into things you don't know very much about, which is the diversification we've seen a lot of in the financial sector.[166]

Evidence by Charles Ross-Stewart, Chief Compliance Officer, EMEA, Citigroup, suggested that even technological economies may be overstated:

    The complexity of the organisation does provide us with a lot of challenge—it provides everybody with a lot of challenge—and the complexity and multiplicity of our technology systems mean that sometimes getting hold of information is burdensome and time-consuming. Having an organisation such as Citi, with 250,000 employees, which has built up over a period of organic growth and acquisition, inevitably leads to quite a complex set of technologies.[167]

77. Growth and diversification into new fields can present challenges for corporate governance. Sir John Vickers told the Commission that "the complexities of management and the lack of awareness at the top of these banks" was "a major issue".[168] Some senior bank executives told us that this problem had been exacerbated by the international nature of growth. Douglas Flint said that, at HSBC, "standards that we believed were being applied globally that were set from the centre were not being applied as they should have been".[169] John Hourican described a legacy of "strategic tourism" at RBS, with parts of the Group "being in too many places, doing too many things".[170]

78. In a speech in 2012, Andy Haldane said "there is now evidence of diseconomies which rise with bank size, consistent with big banks becoming 'too big to manage'".[171] Elaborating in evidence to the Commission, he said that this was still true of apparently strongly performing major banks:

    If anyone was viewed as having emerged successful from this crisis globally, it probably was J.P. Morgan; its risk management was seen as being best of breed, yet we had the London Whale incident, which suggests that a key part of that business was not being managed or overseen from a risk perspective in an effective way. The question you pose is very real. The evidence base is not encouraging about whether the biggest banks in the world can indeed manage themselves across the board.[172]

79. Board Intelligence suggested that running a major bank required skills that are beyond superhuman:

    Expectations on any board are arguably superhuman, but the scale and complexity of the financial service conglomerates creates an additional strain.[173]

Sir Mervyn King, who as Governor of the Bank of England had a substantial range of responsibilities himself, used an example to make a similar point:

    If we had had a discussion around this table before the crisis, and you had said, 'We are getting a bit worried that it is too complex and too big. Let's choose four people whom we really trust to put into Citibank, and they will surely know what is going on.' Well, we might have said, 'Let's start with Bob Rubin, Treasury Secretary in the US, who used to run Goldman Sachs; Sandy Weill, streetwise trader who built up Citibank; Stan Fischer, one of the world's most respected economists, former No. 2 at the IMF, now central bank governor at the Bank of Israel; and Bill Rhodes who has seen every emerging market debt crisis there has been.'

    I think we would all genuinely have thought that you couldn't get four better people to sit there and say, 'Well, let's see what's going on.' But they didn't see what was going on. I think that is evidence that these institutions were simply too big and complex for anyone to genuinely know exactly what was going on. […] These institutions have become absolutely enormous.[174]


80. Several witnesses told us that large banks were manageable, provided they were sufficiently simple. For example, Stuart Gulliver said that while a large and complex organisation would be difficult to manage, "if you're large and reasonably straightforward I believe you can manage these things and control these things".[175] Andrea Orcel, CEO of UBS Investment Bank, said that it was not only size that was important but "complexity and different types of businesses that you understand less of".[176]

81. Bill Winters explained how a large and complex bank might be organised:

    The first two are clear: you can be big and simple, and small, well-focused firms can manage complexity. So I accept the first two. Can you be big and complex? You can, but it is hard and in my opinion […] you can be big and complex if you segment the managerial lines of your business in such a way that each piece is small, so that the complexity is managed at a small level, and if you do not allow an over-emphasis on overarching synergies across these small fiefdoms that you have created. So the very argument for being big is reduced as you slice the business up into silos that are manageable.[177]

Mike Ashley, Head of Quality and Risk Management, KPMG Europe, made a similar point:

    I think the only way you can manage a large complex organisation is by compartmentalising it and breaking it down, and frankly some organisations are better than others at achieving that, and achieving it in a way that none the less means you have visibility from top to bottom and you do not develop fiefdoms that go off and do their own thing. I don't think organisationally it is impossible to do, but it requires a great deal of effort.[178]

82. The Centre for Research on Socio-Cultural Change drew on the theme of "fiefdoms" in writing that major banks such as Barclays and HSBC "are not unitary organisations but loose federations of money making franchises".[179] The Chairman of Barclays, Sir David Walker, endorsed this description of the company he inherited, stating "the whole group did not function as a whole group; it was a set of these separate business silos".[180] The Salz Review of Barclays explained that this led to a "sense of cultural difference and cultural distance between the divisions" that weakened central control.[181] Highly profitable but culturally dubious divisions such as Structured Capital Markets and Barclays Wealth America grew largely unchecked by Group governance. Stuart Gulliver described the disparate activities of different divisions of HSBC:

    At the end of 2010, HSBC was doing auto insurance in Argentina, sub-prime credit cards in the United States and corporate banking in Hong Kong. There is nothing in those activities that is remotely similar. There are no economies of scale from the systems that you can achieve, and there is no common risk platform that you can achieve.[182]

Attempting to explain how money laundering in its Mexican affiliate was allowed to persist, Mr Gulliver noted that HSBC was "in 80 countries"[183] and that each "country head" was allowed "to operate without any great supervision".[184]

83. Wilful over-complexity is not the reserve of the international universal bank. In our Fourth Report, we noted that "HBOS Group operated a federal model, with considerable independence given to the division. Central challenge to the divisions from senior executive management appears to have been inadequate in the case of the three divisions that ultimately caused the most significant losses."[185] Co-ordination problems and a lack of board-level control amplified the ineptitude of the Group risk function, which suffered from a low status relative to operating divisions.[186] Control functions and status are discussed later in this chapter.

84. The Salz Review of Barclays' Business Practices attributes the rise of federalism to the desire to expand quickly:

    Barclays pursued a bold growth strategy […] [and] arguably achieved overall much of what it set out to do. […] The result of this growth was that Barclays became complex to manage, tending to develop silos with different values and cultures.[187]

The Review notes that the controversial Structured Capital Markets business "was run as a free-standing operation",[188] and that the investment bank "operated as a relatively independent business within Barclays".[189] We discuss the growth of the structured capital markets sector within banks in greater detail in Box 4.

Box 4: Structured Capital Markets

Structured Capital Markets (SCM) divisions had a presence in many large investment banks, although SCM in Barclays gained particular notoriety through a number of press articles, suggesting that SCM generated "up to three quarters of profits at Barclays' investment banking operation" and that Roger Jenkins, its head at the time, was "paid as much as £40m a year as a result of SCM's successes".

Tax structuring as a business line developed in the mid to late 1980s within investment banks and was largely client-focused. Shortly afterwards, high street banks developed their own tax structuring businesses to take advantage of their 'tax capacity' - availability of profits from their retail businesses which could be 'sheltered' from tax. By the 1990s, SCM had evolved from a service function into a product group, designing and selling highly sophisticated, complex transactions to minimise tax. By 2000, the business had developed into a world of 'bank-to-bank' reciprocal deals to shelter tax. Some such deals, shortly before the financial crisis, were in the region of £5bn.

Witnesses who previously worked in SCM divisions told the Commission that the sole purpose of SCM was to make money by "minimising tax liabilities of the bank or enabling another bank to minimise its tax liabilities and taking a cut". In terms of culture, witnesses suggested to the Commission that the excessive remuneration paid to SCM units could have led to internal competition between profit centres in banks and an increase in risky behaviour. Executives from Barclays later admitted to the Commission that this business model was inappropriate and Barclays announced on 12 February 2013 that it was to close its SCM unit.

85. The diffusion of Barclays' control culture was accelerated by its purchase of parts of Lehman Brothers' North American operations in September 2008.[190] Bill Winters, who was a senior investment banker at J.P. Morgan before and after its merger with Chase Manhattan, outlined some of the dangers of growth through merger and acquisition:

    The norm in mergers is to try to accommodate the two cultures side by side for a period of time. That leads to compromise in decision making and complexity in the organisation. […] Any incentives that the manager had to indulge in short-term risks to generate profits and perhaps earn money are exacerbated by a desire either to gain a job or to hold on to a job.[191]

Mergers, motivated by "a relentless drive to grow earnings per share",[192] have also left banks with disjointed infrastructure, "limiting the ability of banks to make informed strategic decisions".[193]

86. The incentives for banks to become and remain too big and complex are largely still in place. As well as reinforcing the distorting effects of the implicit taxpayer guarantee, this makes banks as currently constituted very difficult to manage. Incentives to pursue rapid growth have contributed to the adoption by banks of complex, federal organisational structures insulated against effective central oversight and strategic control. These incentives were reinforced as rival banks grew through acquisitions of firms whose standards and culture they scarcely understood. Many of the consequences of unchecked pre-crisis expansion and consolidation remain, as do the perverse incentives that promoted it. As a result, many banks remain too big and too complex to manage effectively.


87. In his General Theory, John Maynard Keynes wrote:

    Too large a proportion of recent 'mathematical' economics are [sic] mere concoctions, as imprecise as the initial assumptions they rest on, which allow the author to lose sight of the complexities and interdependencies of the real world in a maze of pretentious and unhelpful symbols.[194]

In recent years, banking has been increasingly driven by faith in complex mathematical models and quantitative techniques at the expense of judgement and focus on high-level strategic risks. Models of credit, market, and operational risk drive business decisions. In the years preceding the financial crisis, mathematical models were also used increasingly to calculate regulatory capital requirements, as discussed later in this chapter.

88. The complexity of the models used by banks, and the effort expended in building them, led to misplaced confidence in their value and a failure by banks and regulators to question their output sufficiently. Dr Andrew Hilton, Director for the Study of Financial Innovation, told the Commission that banks "got too cocky" over risk.[195] They recruited individuals from mathematics and physics departments who had highly quantitative backgrounds and "fell on the data like a pack of dogs on a dead cow and gorged themselves on it".[196] However, many of the models they produced were based on simplistic or misguided notions of risk distributions and were highly susceptible to exogenous shocks.[197] The steadfast adherence to complex but flawed models was exemplified by a comment made by an official at a major UK bank on the output of a "stress test" exercise used to determine the riskiness of a commercial property portfolio:

    We actually got an external advisor to [assess how frequently a particular event might happen] and they came out with one in 100,000 years and we said "no," and I think we submitted one in 10,000 years. But that was a year and a half before it happened. It doesn't mean to say it was wrong; it was just unfortunate that the 10,000th year was so near.[198]

89. The Basel II international capital requirements regime allowed banks granted "advanced status" by the regulator to use internal mathematical models to calculate the risk weightings of assets on their balance sheets. Andy Haldane described this as being equivalent to allowing banks to mark their own examination papers.[199] A fog of complexity enabled banks to con regulators about their risk exposures:

    [...] unnecessary complexity is a recipe for […] ripping off […], in the pulling of the wool over the eyes of the regulators about how much risk is actually on the balance sheet, through complex models.[200]

As noted in the Commission's Report on HBOS, Lord Stevenson said that staff had devoted "tens of thousands of hours" to try and secure its Basel II waiver, and Andy Hornby conceded that the process was a "huge distraction".[201] The outputs of models did not truly reflect the risk on bank's balance sheets and fuelled a progressive reduction in the amount of capital held by banks against their exposures.[202] As Stilpon Nestor, Managing Director, Nestor Advisors Ltd, wrote, models also acted to obscure emerging risks:

    Boards were following detailed Basel II capital adequacy metrics but ended up missing more than one elephant in the risk room, such as rapidly increasing gross leverage and decreasing liquidity.[203]

The models thus provided false justifications for banks to take and maintain ultimately unsustainable positions.

90. The lure of complexity is not an historic oddity of the pre-financial crisis era. The instruments of measurement of 'Basel III' which we consider further in Chapter 9 mirror many of the problems of the past. Computer-based trading represents another emerging sphere of dizzying new heights of complexity (see Box 5).

    Box 5: Computer-based trading and banking standards

    Algorithmic trading (AT), including its subset of high-frequency trading (HFT), is part of a long term trend of technological development in markets, in which messengers on horseback were replaced by carrier pigeons, which were in turn replaced by telegraph, and so on. However, change has accelerated in recent years. In the near future, trades will routinely take less than a millionth of a second and adaptive trading algorithms will evolve independently of human input.[204] This activity is contended by some to have limited social value.[205]

    AT delivers some benefits to markets, including improved efficiency, liquidity and price discovery and reduced transaction costs.[206] Electronic trading can be more systematically monitored than traditional markets.[207] There are, however, some valid concerns. There is a widespread perception that AT facilitates market abuse.[208] AT has also been associated with market instability, most notably the US "Flash Crash" of May 2010. The paucity of evidence to assess the legitimacy of these concerns points to a worrying lack of monitoring and awareness on the part of regulators.[209]

    An absence of understanding of complex technological developments is not limited to regulators. Modern banks "are essentially technology companies",[210] but management and boards may not be equipped to offer challenge and oversight at the forefront of change.[211] This threatens an "unconscious drift towards a place we don't like".[212]

    A more fundamental question is the role of culture in an increasingly automated world. The growing absence of human interaction and relationships in markets has already contributed to a decline in trust.[213] Algorithms do not have inherent standards or culture: they are, by definition, rule-based and "controls have to be evident in the design".[214]

91. Joris Luyendijk, an anthropologist and journalist, argued that "quants" tend to lack the abilities of a "skilled politician" necessary to rise up bank management echelons.[215] At the same time, managers have incentives to accept the outputs of models at face value, even if they do not understand them:

    In these huge operations, where there are a lot of quants who use terms like "standard deviation" that most others do not understand, it is very tempting to tell yourself that it is all safe. Also, you know that if it blows up, it may blow up years after you have left. […[ Some interviewees describe the CEO as essentially a PR person, keeping in place the illusion that there is control.[216]

92. Risk modelling is symptomatic of wider concerns regarding the ability of boards and senior management to understand the activities of the institutions they are tasked with running. Dr Hilton said:

    You have a big difference in the skill set of the top and board level managers—there is a different age structure and skill set; these are people who probably still have difficulty with their mobile phone—and the people down at the very bottom, who are actually taking the decisions that these guys are ultimately responsible for. [217]

93. Excessive complexity in the major banks is not restricted to organisational structure. The fuelling of the financial crisis by misguided risk models was not simply the consequence of some mathematicians getting their equations wrong. It was the result of ignorance, coupled with excessive faith in the application of mathematical precision, by senior management and by regulators. Many of the elements of this problem remain.


94. The complex structure and diverse activities of many large banks obscured senior executives' understanding of what was really going on in the businesses they were supposedly running. When conduct and risk failures came to light, this ignorance allowed many leaders to profess their shock at what had been happening, duck personal accountability and instead blame systems failures or rogue individuals. Many banks had a structure of cross-cutting functions and committees which meant that key decisions and risks were not owned by single executives but were shared, undermining a sense of individual responsibility.

95. Whether deliberate or not, ignorance and collective decision-making served to create what we described in questioning witnesses as an "accountability firewall" for senior executives. As TheCityUK noted:

    While senior executives are ultimately accountable for the conduct of their staff, making this accountability meaningful poses a genuine challenge in organisations as large and varied as modern financial institutions.[218]

Professor Nicholas Dorn added:

    Those at the theoretical apex of the organisation may know the least about what is going on - partly because they are at some distance from the everyday lives, conversations, transactions and tactics of their subordinates, and partly because they may have a vested interest in not knowing in advance of any misdemeanours that might in the short-to-medium term be highly profitable for the bank.[219]

LIBOR manipulation

96. Three banks (Barclays, UBS and RBS) have so far been fined in relation to the manipulation of LIBOR. In all three cases, senior executives denied having being aware of any indication at the time that false LIBOR submissions were being made to benefit trading positions.[220] Bob Diamond made clear that in the case of Barclays he laid the blame on the fourteen individuals directly implicated, saying "It was wrong. It was not reported up. It should have been reported to compliance and to their supervisors",[221] adding "there are aspects of this that are industry-wide, but this bad behaviour, I am not blaming on anyone. I blame it on these individuals and they are being dealt with".[222] However, the attempted manipulation of Barclays' LIBOR submissions with the intention of personal gain continued for four years. The Treasury Committee noted that such abject and extended failures of compliance were failures "for which the board is responsible" and were only possible if "the management of the bank turned a blind eye to the culture of the trading floor".[223]

97. The conduct of UBS was much more shocking even than that of Barclays. LIBOR manipulation at UBS was very widespread, revealing an appalling failure of internal communication, or even awareness by senior management.. At least 40 individuals made over 900 documented internal requests and over 1,000 external requests to falsify LIBOR, over a period of at least nine years. "At least a further 70 individuals at UBS" were indirectly implicated.[224]

98. Once the financial crisis hit in late 2007, UBS also started to falsify its LIBOR submissions to protect its reputation, because a bank's LIBOR submissions can be seen as an indicator of its financial health. There were several distinct phases between August 2007 and mid-2009 where US Dollar LIBOR submissions were set to "err on the low side", be "in the middle of the pack", track commercial paper rates, and then go back to "middle of the pack".[225] Each phase was initiated by directives from senior managers in Group Treasury or Asset and Liability Management, and emails clearly show why traders believed they were being asked to act this way: "[A]ll senior management [...] want to show the world we are the strongest bank with loads of liquidity".[226] However, senior UBS executives denied having ever been aware of this activity and suggested that it was understandable that such decisions could have been taken without needing to be escalated.[227]

99. Former UBS executives accepted some accountability for LIBOR manipulation after the event. Marcel Rohner, former CEO of UBS, said "I feel accountable for what has happened in the bank under my watch",[228] while Jerker Johansson, former CEO of the UBS investment bank, told us "I accept that I had a responsibility to actively seek out information and things that concerned me".[229] In correspondence subsequent to the hearing, Dr Rohner's lawyer rowed back from his client's evidence. He wrote that Dr Rohner "did not accept at the hearing yesterday any element of personal fault, in fact he specifically denied that he had been negligent."[230] Huw Jenkins, former CEO of the UBS investment bank, wrote:

    I, and my colleagues, made it clear that we deeply regretted both the conduct and the fact that we did not spot this issue at the time, but at all times I acted in good faith to address the risk and other issues that we considered to be the priorities at the time. With hindsight those issues could have been better prioritised but that clearly does not constitute negligence.[231]

100. In the case of Barclays, where manipulation of LIBOR for profit occurred on a smaller scale than UBS but senior executives were involved in decisions to "lowball" LIBOR submissions for reputational reasons, the Chief Executive Bob Diamond wrote to the Treasury Committee:

    As well as accepting the authorities' penalties and apologising, it is important that Barclays takes further action. First, we must demonstrate responsibility. That is why I, and three of my senior colleagues, volunteered to forgo any consideration for bonuses in 2012, recognising our responsibility as leaders of the organisation in which these events occurred.[232]

It was only subsequently, following intervention from the regulators and public and political pressure that the Chief Executive, Chairman and Chief Operating Officer stepped down from their posts.[233]

101. When the FSA announced its fine of RBS for LIBOR manipulation, it was announced at the same time that the head of its investment bank, John Hourican, would step down. This does not necessarily mean that RBS had clearer accountability structures in place than Barclays; it may reflect that the political realities of the fact that someone had to be seen to accept the consequences were better understood. When appearing before the Commission, RBS's executives articulated feeling responsible for failures. John Hourican said:

    I do accept responsibility for the behaviours of our staff, and therefore, I accept responsibility for the failings that were found. It is important that we don't talk about accepting responsibility, and then not do so in our actions. That is why I resigned.[234]

Peter Neilson, who was head of the RBS business area in which the LIBOR manipulation took place, said "I do accept responsibility and I am accountable for those failings", but defended his decision not to offer his resignation: "I believe that we have accomplished a great deal since attempting to right the bank in 2009. I have appreciated being able to play a part in that, and I think I have got some more to offer".[235]

Payment protection insurance

102. The scandal of PPI mis-selling was described in Chapter 2. In written evidence to the Commission, Which? argued that collective responsibility for consumer issues had contributed to conduct failings in this area. In the absence of a "single, defined member of senior management" responsible for following up customer complaints or vouching for the terms of a new product, they argued, incentives to ensure high standards were limited.[236] Which? observed that "not a single individual senior banking executive has ever had enforcement action taken against them for presiding over the mis-selling of products".[237]

103. With reference to PPI, Helen Weir, former Principal, Retail Distribution, Lloyds Banking Group, demonstrated a vague and collective accountability structure:

    Rory Phillips: In your retail role, I think you were ultimately accountable, weren't you, for PPI sales process in the retail bank?

    Helen Weir: It is correct that the retail bank operations were part of my responsibility.

    Rory Phillips: That accountability was reflected, wasn't it, in the reduction by some 25 per cent of your bonus for 2010, which was announced by the group in February 2012, following the increased provisions for PPI?

    Helen Weir: I believe that in that announcement, the board made it clear that what they were doing was reflecting the accountability of the executive directors of the board in those bonus reductions.[238]

104. The FSA explained some of the difficulties of establishing blame at senior levels in the context of conduct cases involving junior staff:

    Decisions were made further down the chain of command. If the delegation was appropriate (i.e. to an appropriately qualified person with suitable resources etc) the more senior individual will not be at fault. In conduct cases (although perhaps less so in prudential matters) the decisions which are made which impact adversely on customers may sometimes be made a long way from the top of the organisation and the senior management and/or board currently have relatively little visibility of them.

    It is unclear who was responsible for a decision (or series of decisions) because lines of accountability are unclear or confused, or because they pass, at some point, through people who are not approved (and are not required to be).[239]


105. One of the most dismal features of the banking industry to emerge from our evidence was the striking limitation on the sense of personal responsibility and accountability of the leaders within the industry for the widespread failings and abuses over which they presided. Ignorance was offered as the main excuse. It was not always accidental. Those who should have been exercising supervisory or leadership roles benefited from an accountability firewall between themselves and individual misconduct, and demonstrated poor, perhaps deliberately poor, understanding of the front line. Senior executives were aware that they would not be punished for what they could not see and promptly donned the blindfolds. Where they could not claim ignorance, they fell back on the claim that everyone was party to a decision, so that no individual could be held squarely to blame—the Murder on the Orient Express defence. It is imperative that in future senior executives in banks have an incentive to know what is happening on their watch—not an incentive to remain ignorant in case the regulator comes calling.

Paid too much for doing the wrong things


106. In Chapter 2, we noted that public anger with banking is fuelled by the seeming disparity between the amount bankers earn and the value they add—or harm some of them cause—for society. This section notes how remuneration in banking seems not really to have fallen since the crisis, despite the clear evidence that many bankers were not as productive as had been previously claimed. It also sets out how the distorted incentives leading to such high pay contribute to poor prudential and conduct standards. Chapter 8 considers in more detail how high pay in banking is the symptom of wider failures, and considers how remuneration frameworks could be reformed to better align incentives.

107. Much has been made of how bank bonuses have fallen in recent years. The Chancellor referred to CEBR estimates that the total City bonus pool has fallen from £11.5bn in 2006 to £1.5bn in 2013.[240] Anthony Browne said that, since 2007, cash bonuses are down 77 per cent and the total bonus pool has more than halved.[241] Between 2010 and 2012, variable pay fell by 28 per cent at Barclays and 51 per cent at RBS.[242]

108. However, total remuneration in banking—including both base salaries and bonuses—has not seen the same level of reduction that these headline numbers would suggest. As the chart below shows, total remuneration across the UK's largest four banks has in fact been much more stable:[243]

Chart 1: Aggregate employee remuneration in large UK banks


(Source: Company reports and accounts and staff calculations. Further detail available in Annex 3)

109. While aggregate remuneration across the sector has remained relatively stable, staff numbers have fallen, meaning that per-capita remuneration has actually increased over recent years. The chart below shows how per-capita remuneration, including both fixed and variable pay, has changed in the UK's largest banks. It can be seen that per-capita remuneration fell sharply at RBS and Barclays in 2008 but that overall most banks' per capita remuneration is now close to or above its pre-crisis level.

Chart 2: Per-capita remuneration in large UK banks


(Source: Company reports and accounts and staff calculations. Further detail available in Annex 3)

110. The discrepancy between the much-vaunted falls in bonuses and the reality of static or rising total and per-capita remuneration is in part due to a shift from variable to fixed pay. For example, at Barclays, the Salz Review found that:

    fixed pay as a proportion of total compensation has changed significantly, increasing on average from 65 per cent in 2010 to 76 per cent in 2012 across the Group. This

    shift has been even more pronounced in the investment bank where average fixed pay has risen from 25 per cent in 2007 to 59 per cent in 2012, and from 6 per cent in 2007 to 32 per cent in 2012 for managing directors only, reflecting both absolute increases in fixed pay and significant reductions in average bonus.[244]

111. Public anger about high pay in banking should not be dismissed as petty jealousy or ignorance of the operation of the free market. Rewards have been paid for failure. They are unjustified. Although the banks and those who speak for them are keen to present evidence that bonuses have fallen, fixed pay has risen, offsetting some of the effect of this fall. The result is that overall levels of remuneration in banking have largely been maintained. Aggregate pay levels of senior bankers have also been unjustified. Given the performance of the banks, these levels of pay have produced excessive costs. Indeed, at a time of pay restraint in the public and private sectors, they will raise significant anger amongst taxpayers who have been required to subsidise these banks. These elevated levels of remuneration are particularly unacceptable when banks are complaining of an inability to lend owing to the need to preserve capital and are also attempting to justify rises in charges for consumers.


112. The opportunity quickly to earn huge amounts creates strong incentives to obtain them. Sadly, such incentives have often led to behaviour which is incompatible with high standards, and which contributed to many of the failures in banking. Andy Haldane explained that the widespread use of return on equity (RoE) in determining individual rewards for bankers resulted in incentives to increase leverage and take undesirable risks:

    It is deeply irresponsible to be using performance metrics that fail to take adequate account of risk. The reason why the return-on-equity metric […] is a problem is that it can be easily gamed by risking up the system through leverage.[245]

113. PWC concurred that this "feedback loop between pay and performance reinforced a certain cycle of behaviour".[246] The Chartered Institute of Personnel and Development wrote that remuneration practices in banking "have not only led to rewards for failure, but have incentivised the sort of behaviours that led to the financial crisis and have damaged trust in the financial system".[247] Global Witness added that banks fail to use non-financial measures of performance in remuneration decisions:

    the pay of bankers is almost exclusively linked to their financial performance ie 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.[248]

114. Compensation in investment banking has largely been funded on a share of profits basis, without employees being required to provide capital.[249] David Bolchover explained that this led to misaligned incentives:

    It is only human instinct that if you have a huge upside reward for taking risk, you will take that risk knowing full well that the worst that can happen to you is that you lose your job in a few years, but you have several million pounds in the bank already. Clearly, there was an imbalance of risk.[250]

Martin Taylor told us that the problems of payment based on profits were exacerbated as banks were "using mark-to-market accounting to increase their profits as asset prices rose in the boom and then paying out the unrealised profits in cash".[251] In their written evidence, the Financial Reporting Council acknowledged concern regarding "the link between volatile unrealised profits and bonuses".[252] Sir Brian Pitman, the long-term chief executive of Lloyds TSB has also highlighted that the special features of the banking sector exacerbated the dangers of linking remuneration to short-term performance. He has said:

    One of the great differences between banking and other activities, is that in banking you can increase the profits simply by changing the risk profile. I was chairman of [the retailer] Next at one time, and we couldn't wake up in the morning at Next and say, what we're going to do is greatly expand our business, what we're going to do is increase the risk profile. But in banking, it's perfectly possible, in the short term […] And if you gear up the remuneration system appropriately, you can become rich quite quickly".[253]

115. Professor Charles Goodhart argued that payment in shares, with the objective of aligning staff incentives with those of shareholders, provided incentives to undertake risky behaviour:

    Bankers are responsive to, and largely remunerated in the same way as, shareholders. They generally have bonuses in equity form; most senior bankers have, and are expected to have a large equity shareholding in their own bank. Equities have limited liability status. The down-side is limited; the up-side is not. This convex pay-off, equivalent to a call option on the bank's assets, makes the pursuit of risk an attractive way of enhancing one's own welfare for a banker. To follow such incentives is natural.[254]

Andy Haldane told us that "the incentives created by paying in shares are every bit as great as the incentives created by paying in cash".[255] Professor Goodhart concluded that incentive structures in banking were so misaligned that bankers were "surprisingly responsible" in the circumstances.[256]

116. The calculation of remuneration in investment banking and at the top of banks remains thoroughly dysfunctional. In many cases it is still linked to inappropriate financial measures, often short-term, while long-term risk is not adequately considered. Individuals have incentives to be preoccupied with short-term leveraged growth rather than sustainability and good conduct.


117. The Commission received evidence on similar flaws in remuneration in retail banking. The TUC noted that, while rewards were of a very different magnitude to those in investment banking, remuneration structures in retail banking similarly promoted undesirable behaviour:

    Just as performance related pay affects behaviour at the higher end of the banking pay scale, it also causes distortions at the bottom end. A sales driven culture with sales targets and performance related pay linked to indicators such as product sales incentivises retail banking staff to sell unnecessary and risky products to households and SMEs […].[257]

Lloyds Banking Group partly conceded this link:

    In the recent past the structure of variable compensation packages across the retail banking industry has been characterised by an excessive emphasis on sales targets. This may, in some cases, have had a detrimental impact on behaviour.[258]

Citizens Advice stated that bank staff had had "incentives to sell products which make a profit for the bank, rather than considering which product is best for the customer's needs and circumstances".[259] Peter-Vicary Smith told us "an Alliance and Leicester salesman at one time would be earning six times as much personal commission for selling a loan with PPI as for selling a loan without PPI—lo and behold, PPI was mis-sold".[260]

118. Stuart Davies, Regional Officer, Unite the Union, told us that a "very aggressive sales culture" still existed in banks.[261] Dominic Hook, National Officer, Unite the Union, added:

    There are still banks today with notice boards on the wall that list all the individuals, with what they have sold in the past week and who is top and who is bottom. […] It creates a lot of stress and means that the pressure on them to mis-sell or to be in circumstances where mis-selling can happen is much greater. We think that it is a cultural thing that comes right from the top of any organisation. [262]

Citizens Advice made the point that the use of sales incentives in the case of PPI had ultimately had "sizeable [negative] consequences for the banks themselves".[263] Paul Geddes, former chief executive of RBS UK retail said that "there was a real risk" with an incentive scheme which gave double sales points for selling a loan with PPI and gave higher points for bigger loans. Ms Weir acknowledged that Lloyds should have done more, saying that the bank "went to great lengths to try to put in the checks and balances, but I think with hindsight, it would have been better to address some of those incentives."[264] Gordon Pell, former Deputy Chief Executive of RBS, said that he did not sign off the RBS frontline staff incentive scheme and was not aware that there were double points for PPI sales.[265]

119. Though they have been much less generous than in investment banking, poorly constructed incentive schemes in retail banking have also hugely distorted behaviour. They are likely to have encouraged mis-selling and misconduct. Senior management set incentive schemes for front-line staff which provided high rewards for selling products and left staff who did not sell facing pressure, performance management and the risk of dismissal. It shows a disregard for their customers and front-line staff that some senior executives were not even aware of the strong incentives for mis-selling caused by their own bank's schemes. These remuneration practices are ultimately not in the interests of banks themselves, still less of the customers they serve.

Inadequate checks and balances


A decline in loyalty

120. The tendency of remuneration systems to reward short-termism and risk­taking has been mirrored in wider bank culture. Sir Alan Budd wrote that the decline of the partnership model led to a two-way decline in loyalty:

    the weakness of employee loyalty was matched by the terms and practices of employment. People could lose their jobs at a moment's notice if market conditions were believed to require it. Loyalty works both ways.[266]

This process, he contended, means that individuals had increasingly worked "at banks" rather than "at banks".[267] Loyalty, where it was afforded, was to "hero" investment bankers,[268] and direct line managers, rather than to the institution, as John Reynolds, a former investment banker, explained:

    The internal culture within investment banks, and the investment banking arms of universal banks, is often based on patronage by individual senior bankers. This results in loyalty required to be shown to individuals rather than the organisation in order to achieve promotion (and pay).[269]

The Salz Review of Barclays showed that individual loyalty to immediate superiors rather than to the whole organisation had led to "different sub-cultures". The report stated that staff "were likely to make their own decisions about values, based on what seemed to be important to their business unit head—or even the individual leaders to whom they reported".[270]

121. Robert Pringle told us that declining staff loyalty to the banks at which they worked had been reinforced by the recruitment of entire teams:

    The ideas of loyalty and long-term service to one's employer and its culture were discarded. Teams of specialists were bought and sold like slaves or football stars.[271]

Andrea Orcel, who was recruited to UBS from Bank of America Merrill Lynch with a £17 million "golden hello",[272] concurred that in taking short-cuts in recruitment, through recruiting teams or pursuing rapid expansion through pay inflation:

    you don't integrate the people into your culture. To grow this business organically, which is the only way you should be growing it, takes a longer time.[273]

A cult of the high-earning individual has led to top traders being promoted to management positions. Joris Luyendijk, an anthropologist and journalist, argued that they were often unsuitable for such positions, suggesting that "the skills you need to be a good trader are almost opposite to the skills you need to be a good manager […] managing or trading are just completely different things".[274] There needs to be a reintroduction of the difference in pay structures between those who trade or transact and are remunerated on those transactions, and those who manage traders. The total remuneration of those who mange should not directly reflect the performance of those who trade.

Front office versus back office

122. Those in control functions tended to be paid far less than those in revenue-generating positions. Richard Goulding, Group Chief Risk Officer, Standard Chartered, explained:

    Clearly in areas such as market risk, you get better paid if you go into a trading or potential sales job than if you remain within the market risk function. That is not to say that jobs in the market risk control function are not well paid; they are, but they are not as well paid as the front office.[275]

In a world where, according to Sir Alan Budd, success is measured by money,[276] this might be expected to reinforce front office primacy. Mr Goulding argued that this is not the case:

    Baroness Kramer: So what would the status be of your folk down on the floor level versus the revenue generators? How would they perceive themselves in relation to the revenue generators?

    Richard Goulding: I frequently receive complaints that the people in risk are actually too powerful in the organisation, which is probably the right sort of complaint to be getting.[277]

Mr Luyendijk disagreed:

    Back-office people say they know when a colleague has to call a front-office person, because usually the colleague reaches a number of times for the phone before he picks it up.[278]

    The remuneration gap, he argued, has resulted in a more fundamental cultural divide along lines of status:

    There are these hugely different activities, but if there is one big divide, it would be between back office, middle office and front office. There is an overriding sense of identity that people have when they are in one of those three places. Some of the anecdotes are just so telling. I spoke to a gay banker who wanted to organise a networking event for gay bankers in his bank. He finally got a lot of people whom he knew and who were out to come to the thing, but then those bankers realised there would be gay bankers from the back office, middle office and front office. The front-office gay bankers said, "No, I'm not going to an event with back-office bankers." That really tells you something about how deep these things go.[279]

123. At its worst, this cultural divide has manifested itself in a climate of bullying and fear, whereby compliance staff were unable to challenge the front office. A report into Barclays Wealth America concluded:

    The current leadership team have pursued a course of "revenue at all costs", taken a conscious decision to ignore support functions, reinforced a culture that is high risk and actively hostile to compliance, and ruled with an iron fist to remove any intervention from those who speak up in opposition.[280]

Personality types

124. Joris Luyendijk said that trading floor recruiters select "testosterone-infested alpha males" and explained that this is seen as a useful quality in a highly dynamic environment as "nice guys finish last on the trading floor".[281] In a 2008 study of men on a City trading floor, Professor John Coates found that a combination of instinctive risk-taking and herd behaviour tended to result in irrational decisions and exaggerated market swings.[282] Mr Luyendijk quoted the concerns of a regulator that he was "not so much worried about a banker lying to me; I'm worried about a banker lying to himself that he oversees the risks taken".[283] The Chartered Institute of Personnel and Development told us that the banking industry had created a "somewhat self-reinforcing, monolithic working culture [...] with the same types of people recruited time and again", reinforced by "rewarding the same behaviours and personality types based on delivery of financial performance above all".[284]

An eroded professional ethos?

125. There was no golden age of banking standards in the UK. While a customer in the 1950s may have received a personal service from a bank manager who was a pillar of the local community, the majority of the population were unbanked, "branches closed at 3pm, bank charges were levied entirely at the manager's discretion, and credit was confined to overdrafts and short term credit".[285] The banks "operated as a closed shop when it came to interest rates, wages and salaries, protected by an agreement not to poach each other's staff".[286] As Sir Alan Budd wrote, "it was not obvious [...] that the careful and rather comfortable way of doing business was in the best interests of the customers".[287] Sir David Walker told us that the City of London of "the good old days" was "tainted by what we would now regard as clear malpractice".[288]

126. Banking prior to the Big Bang was, however, subject to greater restraints. Rigid hierarchies and long careers rewarded loyalty and prudence. In the City of London, unspoken agreements and social norms shaped conduct. Though the prevailing culture was "incompetent, clubby and protectionist",[289] "the ethos was at least as important as regulations in controlling behaviour", with the worst excesses constrained by the need to maintain social standing. [290] Anthony Sampson wrote of the City having a "tribal past" with no need for "fuss and lawyers", but relying on a tradition of mutual trust.[291] Rewards for risk-taking were not so high as to override reputational concerns.

127. These, largely domestic, established codes of behaviour have largely been eroded. Witnesses pointed to the role of globalisation. Robert Pringle argued that international "investment banks' business model and ethic seemed ideally suited to the emerging global financial market", with a concomitant influence on the prevailing culture.[292] Virgin Money pointed to the impact of the increasingly international nature of bank staff:

    With people from different geographic and cultural backgrounds, there may not be a shared intuitive response to issues as they arise. This may lead to reliance on the rules as stated—or even to the view that, if something is not specifically prohibited in the rules, it is permitted.[293]

The Financial Services Consumer Panel linked the decline of personal interaction on trading floors to the Big Bang:

    The so-called "big bang" in wholesale market trading of banks and investment firms of the 1980s took away the physical trading floors that relied on personal contact and relationships between the parties and introduced electronic exchanges and trading platforms. [...] What was once the basic tenet of the London stock exchange "my word is my bond" is no longer given credence. As practitioners and customers no longer exchange so many words, fewer bonds can be created.[294]

Sir Alan Budd described how the emerging investment banking culture at Barclays clashed with that of the established clearing bank:

    The clearing bankers regarded the investment bankers as overpaid, reckless and not loyal to the bank. The investment bankers regarded the clearing bankers (who provided the capital) as timid, unimaginative and slow.[295]

Sir Alan suggested that the approach of traditional banking was no match for the seductive fast buck of the brash interloper:

    By this time another cultural shift had taken place in investment banking. As trading profits in securities and derivatives rose inexorably in buoyant markets, the power of the traders rose in their organisations at the expense of more staid corporate financiers. The individualistic, bonus-driven ethos of the trading floor permeated institutions in which the idea of fiduciary obligation to customers was ebbing away.[296]

128. The increasing lack of professional identity in banking has facilitated a process whereby people with little understanding of the distinct characteristics and risks of the industry have assumed leadership positions. Prominent examples of this trend are Fred Goodwin, a chartered accountant, becoming chief executive of RBS, and James Crosby and Andy Hornby, an ex-actuary and a retail manager respectively, becoming successive chief executives of HBOS.

129. Professional standards in banking were, according to Hermes Equity Ownership Services, "never akin to those developed, imposed and enforced by the genuine professions".[297] The dilution of traditional codes of behaviour, combined with the specialisation demanded by the complexity of modern banking, have rendered industry bodies increasingly irrelevant. The Chartered Institute of Bankers, founded in 1879 and awarded a Royal Charter in 1987, re-formed as the ifs School of Finance, a commercial examining body.[298] The Chartered Institute of Bankers in Scotland, founded in 1875 and awarded Royal Charters of incorporation in 1976 and 1991, has expanded its ambitions to the entire UK.[299] However, it has just 4,000 chartered bankers on its books and felt unable to withdraw the membership of Fred Goodwin, who has lost both his knighthood and the opportunity for golf club membership, in the absence of formal regulatory intervention.[300]

130. It would be wrong to indulge in misplaced nostalgia about either the friendly community bank manager of bygone days or the quintessentially British culture of the City of London prior to the emergence of the universal banking model. Nevertheless, changing incentives in the sector, together with the impact of globalisation and technological change, have eroded cultural constraints upon individuals' behaviour. Banking now encompasses a much wider range of activities, has fewer features of a professional identity and lacks a credible set of professional bodies.

Unreported misconduct

131. The erosion of professional standards in banking is such that those committing misconduct have not always felt the need to be discreet. As noted by Robert Pringle, the culture of UK banking has become one of "what you can get away with", rather than "what is right".[301] Barclays Wealth America pursued a course of "revenue at all costs", driven by "a culture of dominance and fear" that was actively and openly hostile to compliance.[302] Retail banks have not been immune to blatant misconduct. Dominic Lindley, Principal Policy Adviser, Which?, said that some PPI products were "so toxic and so expensive, that they should not have been sold to any consumers".[303]

132. One of the most striking features of the series of banking conduct failures has been the absence of whistle-blowing. Ian Taplin noted the extraordinary fact that "there is no public record of any banking employee raising concerns or whistle-blowing" with regards to PPI.[304] The attempted manipulation of LIBOR at Barclays, UBS and RBS was found by the FSA to have continued for a combined total of nearly 20 years, with the direct involvement of 78 individuals in nearly 1,300 documented internal requests and well over 1,000 external requests for alternations to submissions.[305] Much of this manipulation was "deliberate, reckless and frequently blatant".[306] However, no one blew the whistle.

133. John Hourican, the senior RBS executive who resigned over LIBOR manipulation despite not being found personally culpable, told us that, in a healthy bank, collective responsibility would snuff out poor behaviour at source:

    Having a lot of whistleblowing in a company that is not part of the normal running of the company is almost as bad as having none, because what we want to have is a culture where people hold each other to a high level of moral account in the company—that is certainly what I would like to aim for.[307]

Joris Luyendijk told us the pervading culture of banks "is very much organised around silence".[308] Martin Woods, a whistleblower, expanded on this, noting that those who witnessed wrongdoing "become passive observers" and were influenced by a "gang mentality" to accept the status quo.[309] Neil Jeffares, a former investment banker, said that whistleblowers could be ostracised by their peers:

    Bankers who object to unethical practices, or simply to excessive risk, will be labelled as trouble-makers or just treated as "not a team player". Their departure from the bank may be covered under a variety of headings and protected through rigorous compromise agreements. Since it is unlikely that the practices they object to will result in criminal convictions, they are rarely in a position safely to communicate their experiences in public.[310]

134. Misconduct has been propagated by this manifest failure of bankers at all levels to accept responsibility. Professor Nicholas Dorn, Erasmus School of Law, Erasmus University Rotterdam, wrote that the incentives of middle and low level employees are such that they "can passively gain from the recklessness and misdemeanours of their peers".[311] Neil Jeffares wrote that a failure to acknowledge misconduct is not necessarily tantamount to dishonesty. He argued that a "generation of bankers" has "willingly adopted" faith in the efficiency of the market "as an excuse for not considering the broader implications of their conduct" and suggested that many "may genuinely believe that they are doing nothing wrong if neither statute nor regulation prohibits a profitable practice".[312]

135. The professions may not be paragons, but they do at least espouse a strong duty of trust, both towards clients and towards upholding the reputation of the profession as a whole. In contrast, bankers appear to have felt few such constraints on their own behaviour. Few bankers felt a duty to monitor or police the actions of their colleagues or to report their misdeeds. Banking culture has all too often been characterised by an absence of any sense of duty to the customer and a similar absence of any sense of collective responsibility to uphold the reputation of the industry.


Maginot lines of defence

136. The major banks typically told the Commission that they operate a "three lines of defence" control framework.[313] The Chartered Institute of Internal Auditors explained that the first line "is line managers and staff who own the risks that they take every day", the second is "specialist risk management, control and compliance functions" and the third is internal audit.[314] The following chart, reproduced from a paper by the Institute of Internal Auditors, illustrates the roles of each line of defence:[315]
First Line of Defence Second Line of Defence Third line of Defence
Risk Owners / Managers Risk Control and Compliance Risk Assurance
- operating management - limited independence

- reports primarily to management

- internal audit

- greater independence

- reports to governing body

137. Through this chapter, we have reported evidence that the major banks are so large and complex as to be unmanageable, are beset by mis-aligned incentives that promote risky behaviour and are subject to a dearth of accountability. The highest revenue earners on the front line attain untouchable status, as a derivatives trader told the Guardian banking blog:

    You now have a generation who were told as graduates by their bank: we'll make you rich. They weren't taught to think in terms of risk. Basically at banks it's quite simple: if you are generating £100m a year in profits, you can be the biggest arsehole and get away with it.[316]

Given that the three lines of defence model operates in this environment, it is perhaps not surprising that the examples of its use heard by the Commission were so shambolic.

Dazed and confused

138. Many of those responsible for the three lines of defence system in banks seemed confused by its operation. Mike Walters, the then Group Head of Compliance at Barclays, suggested that compliance was a first line responsibility:

    I am in charge of the compliance function, but the first line of defence has responsibility to run its business in a controlled way. It is compliance's responsibility to help that happen. Clearly, here it did not, and that is regrettable, but it is not the compliance function's responsibility to make Barclays compliant.[317]

The new Barclays Head of Compliance and Government and Regulatory Relations, Sir Hector Sants, later told us that he "completely and utterly" disagreed with that statement.[318]

139. Some banks' control frameworks are hardwired with an absence of personal responsibility or accountability. The following question was directed to five senior Standard Chartered executives, including Richard Goulding, the Group Chief Risk Officer:

    Mark Garnier:[…] If there is a risk management failure within your organisation, which one of you would the chief executive officer hold responsible?

    Don't all rush at once.

    Richard Goulding: It would be any of us who are either in the first or second line of defence, according to our model. Both the individual who initiated or incurred the risk and the member of our organisation—up to and including me—who is the second line of defence, would be held jointly accountable.[319]

Michael Roemer, Chief Internal Auditor of Barclays, said similarly, "ultimately, I think, the buck stops, depending upon the issue, across any one of the lines of defence".[320] This theme was taken up later in the same evidence session with Robert Le Blanc, Chief Risk Officer, Barclays:

    Mark Garnier: I am still really struggling to find out where the buck stops.

    That is a stony silence. So with none of you, obviously. The board, the regulator, where does the buck stop? Who is taking responsibility for compliance? Who ultimately has their head on the block?

    Robert Le Blanc: The executive committee of the bank takes responsibility for all aspects of—

    Mark Garnier: So there is no individual.

    Robert Le Blanc: The individual—let us use risk as an example—

    Mark Garnier: The fact is that we have been at this for 20 minutes now and no name has come up. Is it the chairman, is it the chief executive, is it the head of compliance?[321]

140. Roger Marshall, Chairman of the Institute of Internal Audit Committee on Internal Audit Guidance for Financial Services, told us that the first and second lines of defence "sometimes blur", with the second line "validating first-line decisions".[322] An example given by Barclays demonstrated how this can blur responsibility, potentially exonerating front-line staff from mistakes:

    Mark Garnier: Is there ever any perception among front-line staff that the control employee—the second line of defence—who approved a bad deal is the more likely to be sacked of the two people than the person who did the deal?

    Rich Ricci: No. If there is a bad deal, I think that the buck stops with the business and I think they expect to feel the heat on the deal. I want to be clear, but obviously there are circumstances where if the advice they got was wrong or if there was an issue with the second line of defence in the execution of the deal, that may be different.[323]


141. Dr Andrew Hilton, Director, Centre for the Study of Financial Innovation, expressed concern that adoption of the fashionable three lines of defence framework was being used as a poor substitute for a genuinely effective control framework:

    I worry slightly that—this is an example of Goodhart's law[324]—as soon as you put a name to something and you identify it as a clear procedure, it becomes less useful, because it becomes, essentially, a box-ticking exercise. You ask, "Have we done what 'three lines of defence' says?", and so long as you have ticked the boxes, you have met your obligations, whether you are in the first, second or third line.

    [...] It reminded me all too much of enterprise risk management from before the crisis. I remember going to a presentation by one of the major consultancies where "enterprise risk management" had a trade mark by it—it was being peddled as a solution from that particular company. "Three lines of defence" is being peddled, I am afraid, in rather the same way—as a solution, when it is really just a box-ticking exercise. In a way, you should forget it. You have got to embed this in the culture of the organisation, whether it is three lines of defence, four lines, or however many—it does not matter.[325]

As a result of the adoption of the three lines model in process but not in spirit, Dr Hilton added, the system becomes "gameable".[326]

142. Witnesses described adherence to procedure with little regard to judgement throughout the three lines system. Paul Lawrence, Group Head of Internal Audit, HSBC, acknowledged that his department had indulged in box-ticking at the third line:

    Baroness Kramer: In a sense, you were not looking at judgment; you were only looking as to whether people had taken the procedural step. Is that what you are saying?

    Paul Lawrence: I think that is a fair comment. It is actually very difficult for an audit unit, based on the skill sets it had and where it traditionally was in the organisation, to pass an opinion on judgments or issues of strategy.[327]

Joris Luyendijk referred to box-ticking as the second line of defence:

    Now, what the trader built was perfectly legal. It would have made money for the bank—or it seemed to make money for the bank. It stayed within all the rules. He probably went to all his compliance people and ticked all the boxes. Most traders talk about compliance as box ticking, or hurdles. They have externalised ethics: once you have got past the priest, you are fine.

Banks tend to have departments tasked with dealing with regulators, enabling the rest of the company to get on with making money. Professor John Kay noted:

    If you go into financial institution after financial institution, you will see firstly that regulation is regarded unequivocally as a nuisance, and, secondly, that regulation is largely entrusted to a department whose job it is to deal with regulation, and that department is itself regarded as a nuisance.[328]

143. The "three lines of defence" system for controlling risk has been adopted by many banks with the active encouragement of the regulators. It appears to have promoted a wholly misplaced sense of security. Fashionable management school theory appears to have lent undeserved credibility to some chaotic systems. Responsibilities have been blurred, accountability diluted, and officers in risk, compliance and internal audit have lacked the status to challenge front-line staff effectively. Much of the system became a box-ticking exercise whereby processes were followed, but judgement was absent. In the end, everyone loses, particularly customers.

Regulation: barking up the wrong tree


144. The underlying causes of poor banking standards do not lie only in the banks themselves. The financial crisis, individual bank failures and the recent string of conduct failings have all been characterised by poor regulation in the UK and in many other countries. In this section, we consider evidence as some of the underlying flaws in banking regulation and the extent to which they remain.

145. Lord Turner told us that "regulatory failure [was the] supporting mechanism that allowed"[329] the prudential and conduct failings that have led to the collapse in trust in banking standards.[330] A new regulatory regime has since been introduced. Lord Turner told us that the culture of regulation had been fixed:

    Chair: [...] I am asking you, one, whether you think there has been something quite seriously wrong with the culture of regulation and, two: has it been fixed?

    Lord Turner: Yes, I think it was wrong, and I think it has been fixed.[331]

146. Martin Wheatley said that "regulatory failure [...] was a failure of philosophy".[332] As Lord Turner argued, the long periods between banking crises tend to breed complacency in regulators:

    The classic problem for human institutions and for the design of our regulatory structures and our policy is how do we design against it in 25 years' time, when the generation of those who were there in October 2008 are in retirement and we have another: "This time it's different. This time we're cleverer than the previous generation." That is the institutional challenge, and we have got to try and embed the intellectual challenge, the counter point of view—but also try and embed through what we do on structure things which are resilient to changes in intellectual fashion.[333]

This complacency led to regulation which, according to the Leaders' Statement at the 2009 G20 Summit in London, tended to "amplify the financial and economic cycle".[334]

147. Regulators also showed a tendency to focus on the wrong things. The FSA's own report on the failure of RBS acknowledged that "discussion of 'key priority risks' or of 'key risks to FSA's objectives' were strongly skewed towards conduct issues".[335] Of the "major topics" discussed at the FSA Board between January 2006 and July 2007, just one out of 61 related in some way to bank prudential risks and issues.[336] Despite this supposed focus on conduct prior to the crisis, it was during this period that much of the poor behaviour leading to later conduct scandals also occurred. In this section, we examine the ways in which regulatory failures contributed to poor standards. We consider the regulatory and supervisory approach further in Chapter 9.


Judgement versus rules

148. Andrew Bailey described the new PRA approach in his evidence to the Treasury Committee as one where "supervisors concentrate on the biggest risks to our statutory objectives posed by the firm, rather than pursuing a myriad of issues that in some cases resulted in the FSA being more like an internal audit function than a regulator".[337] These comments echoed those made at the formal launch of the FSA by its then Chairman, Sir Howard Davies, in November 2001:

    We need to alter the way we deal with firms. We don't want—and they don't want—a box checking routine. Our risk-based approach should ensure that in future, when we visit a firm we have a clear purpose in doing so. [338]

Michael Foot told us that prudential matters lend themselves to judgement-based supervision, but that regulating conduct tended to involve more rules:

    there are very different roles for the rules-based and judgment supervision in the different areas of the business. On the prudential side, for example, there is an awful lot of judgment that is required. In some of the areas like conduct of business or maybe anti-money laundering, the role for rules is significantly greater. [339]

149. When asked how he would ensure that the FCA would pursue judgement-based regulation, Martin Wheatley acknowledged that the FCA was at the mercy of the wider mood and that criticism of it could encourage box-ticking:

    [...] individuals obviously respond to the stimuli that they are given and, at the moment, those stimuli—this is the messaging from me, from Parliament and, I think, from Ministers—are that we want a different style of regulation. At the moment, I think that we are seeing people responding to that. If there is heavy criticism—if things are not perfect and if some decisions are not as some people would want - there would be a tendency for people to want to revert away from taking the risk of making judgments.[340] Which? warned that the regulator's confidence and willingness to take action has been affected by political influence in the past:

    the political environment in which the regulator was operating also played a part in its failure to take action to protect consumers and to enforce high professional standards. Politicians on all sides queued up to criticise the regulator as promoting 'chronic overregulation', inhibiting 'efficient businesses' or undermining the competitiveness of the UK as a location for financial services.[341]


150. Andy Haldane argued that the adoption of complex regulatory rules reinforced a tendency towards box-ticking, telling us that "one of the incentive costs of having a very detailed and complex rule book is that you cannot be seen to override it with your own judgment".[342] He continued by suggesting that the way to ensure regulators "act less defensively and in a way that protects the system rather than themselves is sometimes to give them more discretion and fewer rules to play with in the first place".[343] Douglas Flint warned of a tendency to have faith in the outputs of models because they are "thought to have been constructed with huge intellectual rigour whereas a common-sense approach might say that it doesn't make sense".[344]

151. Thomas Huertas told us that complexity in banking regulation may be necessary because banking itself is complicated.[345] Andy Haldane has argued, however, that "As you do not fight fire with fire, you do not fight complexity with complexity. Because complexity generates uncertainty, not risk, it requires a regulatory response grounded in simplicity, not complexity".[346] Sir David Walker also argued that "responding to complexity in banking with more complex rules" is a mistake because "people in investment banking and elsewhere are pretty clever, and if you set out a rule these people are very good at devising ways around it".[347] Andrew Bailey concurred that the "industry is tremendously innovative in thinking of ways to dress things up to look slightly different" to satisfy the detail, but not the spirit, of complex regulations.[348] Carol Sergeant told us that excessive complexity in regulation impeded its effectiveness by giving "an invitation for clever people to game" the system.[349] The Basel II and Basel III capital regimes were often cited as examples of excessive complexity in evidence to the Commission. We discuss the Basel III regime further in Chapter 9.


An anti-competitive instinct

152. In his 2000 review of competition in banking, Sir Donald Cruickshank referred to the "old regulatory contract":[350]

    an informal contract between successive governments and banks, designed to deliver public confidence in the banking system. In return for cooperating in the delivery of Government objectives, the banking industry escaped the rigours of effective competition. This contract cannot coexist with desirable levels of innovation, competition and efficiency in UK banking markets.[351]

John Kay argued that the vestiges of the regulatory contract remain:

    throughout the 20th century, we maintained stability in British banking through oligopoly, with minimal competition, no new entry and no banking failure of any significance. Perhaps that was a good bargain: but whether or not it was, it is a bargain that is no longer available. Now we have lost the assurance of stability, but experience fully the disadvantages of oligopoly.[352]

Michael Foot observed that regulators are "very risk averse", which tended to act against authorising new entrant banks. He explained that allowing a small or innovative entrant to fail "should actually be beneficial for the system" from a "competition and culture point of view".[353] John Kay explained that regulators tended instinctively to favour the familiar:

    There is a very real phenomenon of what you have described as regulatory comfort. At the moment we are in the process of encouraging people to establish new banks, but implicitly and explicitly we say, "If you are going to be a new bank, you have to be pretty similar to an existing bank."[354]

153. Diane Coyle, founder of Enlightenment Economics and a former member of the Competition Commission, explained that "regulators tend to regulate and they do not think about competition as a tool that they can use".[355] John Fingleton added that "when you are a regulator, you are probably over-confident about the ability of regulation to solve every problem".[356]

Absolving management of responsibility

154. Michael Cohrs told us that he was "not optimistic that you can change the culture of an institution through regulation" and that regulators could merely "create the right incentives and hope".[357] Andrew Bailey warned of bank management seeking to "outsource" cultural change to regulators, stating that it would be "an abandonment of responsibility".[358] The Salz Review of Barclays Bank agreed that regulators were not equipped to change banking culture:

    It is understandable, and in many respects necessary, that since the start of the financial crisis, there has been an explosion in new regulation and in the intrusiveness of regulators. However, regulation alone cannot address the fundamental underlying causes that led to the business practices which are in the spotlight - the cultural shortcomings we found.[359]

Hermes Equity Ownership Services wrote that they were concerned that, following the financial crisis, FSA regulators erred towards being over-intrusive "shadow directors". This encouraged a culture in banks of narrow compliance with rules:

    The risk is that rules will inevitably lead to formal, legal compliance with the letter rather than the spirit of the law or regulation. In turn this leads to behaviour that is focused on formal, defensive compliance (which easily drifts into a gaming of the system) rather than the sort of culture and approach that we should all be seeking, which is a dynamic of seeking improvement within appropriate risk parameters rather than mere compliance.[360]

155. Which? described a culture where strict conformance with regulation was used as a substitute for standards:

    In too many banks a "tick-box" culture developed which saw regulation or regulators as the only arbiters of acceptable behaviour. We are aware of an instance where a firm identified "no major FSA concerns" and "no major regulatory sanctions threatened" as the only indicators that senior managers had met their target of treating customers fairly.[361]

Peter Vicary-Smith explained that banks took this approach to PPI:

    they were so embodied in a culture that, as long as they did exactly what the FSA told them to and ticked the box, they did not have to worry about anything else. In a sense, what we need is the banks to grow up. The analogy I use is that, when my children were five, I used to tell them what to do. Now they are 18, I expect them to use some judgment of their own interpretation and behave with integrity and so on. But the banks still seem to be happier in the culture in which as long as they comply with exactly what the regulator says, they do not have to worry about anything else.[362]

Clive Briault, former Managing Director of Retail Markets, FSA, explained that the regulator was complicit in this absolution of responsibility, stating that the "extension of the rules was very much at the FSA's initiative".[363]


156. Regulators are not remotely as well paid as the regulated. Michael Foot used a football analogy:

    The way I used to put it, certainly in my Bank of England days when Wimbledon were in what was then the premier league, was that I played with a team like Wimbledon that had been put together out of people who nobody else would look at. I didn't have any money to buy star players.[364]

Douglas Flint praised the "intellectual qualities" of the staff at the Bank of England and the Treasury, but expressed concern about the "depth of talent". He cited the example of Singapore, which had been successful by paying regulators salaries "equivalent to those they are regulating".[365]

157. Several former regulators told us that the pay differential was not a major problem. Lord Turner said that "the institutional ethos and the fascination with the job" compensated for "a significant period of time".[366] Carol Sergeant, a former Managing Director of the FSA who later joined Lloyds Banking Group, said that regulators offer "extremely interesting jobs that are, actually, jolly well paid".[367] Douglas Flint suggested that the "intellectual quality" of regulatory work was a determinant of the quality of staff:

    If the role of the supervisor is much more to be high-level, understanding of the risks, and dealing at a senior level in organisations, that is a much more interesting career than the kind of much more minute data gathering, sticking it into a matrix and determining whether it comes out right. I think if the intellectual quality of the role is higher you will get better people.[368]

Sir Mervyn King told us that intellectually demanding work was more likely to fall on the prudential, rather than conduct, side:

    the two styles of regulation are naturally very different. One is naturally a compliance-driven style and the other is inevitably, or should be, in my view, a very close and careful look at the balance sheet risks of those institutions and judgements made by the regulator.[369]

158. That regulation is well-intentioned is no guarantee that it is a force for good. Misconceived and poorly-targeted regulation has been a major contributory factor across the full range of banking standards failings. Regulators cannot always be expected to behave as disinterested guardians who will pursue the "right" approach. They are faced with complex challenges to which the appropriate solutions are ambiguous and contested. They have not in the past always risen to those challenges satisfactorily. They need to resist the temptation to retreat into a comfort zone of setting complex rules and measuring compliance. They also need to avoid placing too much reliance on complex models rather than examining actual risk exposures. Regulators were complicit in banks outsourcing responsibility for compliance to them by accepting narrow conformity to rules as evidence of prudent conduct. Such an approach is easily gamed by banks, and is no substitute for judgement by regulators.

A lack of market discipline


159. Andrew Lilico, Director of Europe Economics, argued that there needed to be more focus on competition, and less on regulation, in improving banking standards:

    Any level of regulatory oversight sufficient, by itself, to maintain high standards in an industry as complex and multi-faceted as banking will almost inevitably involve such onerous intervention as to stifle the healthy functioning of the sector. It is simply a delusion to imagine that in a modern economy, in which banks are the main allocators of capital, regulatory supervision could ever be the main mechanism to maintain standards.[370]

Dr Diane Coyle agreed that competition was "less direct […] but […] more effective" than regulation in raising standards.[371] Clare Spottiswoode outlined how competition could act to improve culture in banking:

    People move their custom if you do not provide a good service with a good product at a good price. If you do not do these things well, you lose your customers. Customers become the heart of your business [...] It is not that competition deals with culture directly; it is that if you have a bad culture, you do not succeed. It is an indirect and really strong impact of good competition.[372]

Competition is clearly, however, not a cure-all solution to banking standards problems. Many areas of investment banking are highly competitive, but it has been the home of many of the most egregious failings of banking standards, including LIBOR manipulation. In this section, we examine contributory factors to a lack of competitive pressure to improve banking standards.


160. Earlier in this chapter, we established that banks have incentives to become very large. This is partly due to the implicit taxpayer guarantee which, as the New Economics Foundation wrote, "accrues almost entirely to the largest banks and acts as a significant distortion to market competition and a barrier to new entrants".[373] By definition, it also acts as a barrier to exit: a major incumbent will not be permitted to fail and leave the market. We also referred to incentives for regulators to favour major, established banks. These factors have helped to sustain highly concentrated markets in parts of banking.

161. Two crucial markets, personal current accounts (PCAs) and SME banking, are particularly concentrated and have become more concentrated in recent years, [374] a process prompted by a series of mergers during the financial crisis. The PCA market is the cornerstone of the UK's retail finance system: 94 per cent of UK adults have at least one,[375] and they act as "gateway" to other products.[376] The four large providers now have "around 75 per cent" of the market.[377] The SME banking market is yet more concentrated,[378] and in some geographical areas there is no choice at all. David Richardson, Federation of Small Businesses Development Manager for Highlands and Islands, told us that "banks take a like it or lump it approach" to small businesses because "the customers have no choice or very little choice".[379] These markets exhibit many of the symptoms of oligopoly (see Box 6).

    Box 6: Oligopoly

    An oligopoly is a market dominated by a small number of firms. In an oligopolistic market, an individual firm can influence the market price. This means that firms are interdependent and their interactions are strategic.

    Oligopolies tend to result in poor outcomes for consumers. Firms in oligopolies have incentives to collude to extract economic rent, through, for example, resisting the market entry of potential competitors. Even if firms do not collude, the market can bear the hallmarks of an apparent cartel. Prices in oligopolies can be notoriously sticky: competitors will tend to match a price cut (as demonstrated in a baked bean "price war"), but not a price rise. As a result, the incentives to compete on price can be very limited. Instead, firms in oligopolies tend to focus on non-price competition. It is no coincidence that advertising, brand differentiation and customer loyalty schemes are so common in oligopolistic markets.

    Oligopolistic markets are not necessarily bad for consumers. Some such markets are highly competitive, with supermarkets a commonly used example. In such circumstances, economies of scale can be passed on to customers.

162. Sir Donald Cruickshank told us that market concentration in itself is not deterministic of competition.[380] Many concentrated markets are very competitive.[381] Lloyds Banking Group argued that UK banking is one of them:

    The level and effectiveness of competition in retail and wholesale banking markets (domestically and internationally) is not a cause of any alleged problems for professional standards in UK banking. On the contrary, the 'virtuous circle' (by which consumers can access and assess products and services and then act by switching supplier if they are dissatisfied or a better offer is available) drives competition and helps maintain professional standards.[382]

Just three per cent of consumers switch their main current accounts over a twelve month period.[383] Benny Higgins, Chief Executive of Tesco bank, suggested that low switching rates could indicate that "many people are actually happy with the bank they are banking with".[384] However, there are other potential explanations. Diane Coyle suggested that customers do not switch because of the risk of "something that is very disruptive to their lives going wrong", especially given that the service to which they would be switching would be "very similar to the service that they would be leaving".[385]

163. Lloyds Banking Group, in a 2011 submission to the Treasury Committee, argued that there was "no correlation between concentration and consumer outcomes".[386] They suggested that, if presented with a superior offer to the incumbent banks, customers would be equipped to exercise choice:

    Whilst new entrants and smaller competitors might have some difficulty in expanding their market share very rapidly if they followed similar competitive/pricing strategies as incumbents, the ICB has presented no evidence to suggest that consumers are inert or unresponsive when a competitor does something more innovative or radically different.[387]

164. John Kay argued that banks perceive the market to be very competitive, but this does not result in improved service and choice for customers:

    We have the paradox in banking at the moment—if you talk to people in Lloyds and HSBC, on the ground, they will describe their business as incredibly competitive, and you sort of see what they mean. But it doesn't look competitive to you and me, because we regard these institutions as being, almost, difficult to distinguish from each other. A way I put in once was to say that the competition between Tweedledum and Tweedledee matters a lot to Tweedledum and Tweedledee, but not to anyone else.[388]

Diane Coyle made a similar point, linking illusory competition back to market structure:

    If you talk to bankers they will say that it is a very competitive industry—competition is very fierce. What they are thinking about is having to get products into the best-buy tables, and offer very good interest rates, and so forth. That is classic oligopolistic rivalry, where they are competing on a narrow range of products for a small group of customers. That is subsidised by high margins on other products in uncompetitive areas of the business. I think the language that they use for consumers who shop around to get the best interest rates is quite revealing. They call them rate tarts.[389]


165. John Fingleton identified market entry, alongside switching, as one of the potential "fundamental drivers of competition" in banking markets.[390] A wide range of barriers to entry were identified to us, which made it, according to Sir Donald Cruickshank, "extraordinarily difficult for a genuine new entrant to come into this marketplace".[391] Earlier in this chapter, we referred to instinctive regulator opposition to competition. Regulatory barriers to entry included:

·  a lengthy authorisation process with limited support from the FSA;[392]

·  capital and liquidity requirements that put new entrants at a disadvantage compared with large incumbents;[393] and

·  the Catch-22 situation whereby the FSA will not authorise a new bank until it has the appropriate people, processes and infrastructure in place, while investors are reluctant to commit resources or staff to join the bank until a licence has been secured.[394]

The FSA published a review of barriers to entry in March 2013.[395] In Chapter 5 we consider the extent to which the measures proposed address these issues.

166. Clare Spottiswoode explained that arrangements for access to the payments system also acted as a barrier to entry:

    It is undoubtedly the case that it is really expensive and difficult to access our payments systems at the moment. If you are a challenger bank, there is a huge up-front cost of getting your IT systems in place and an additional huge cost of getting your own access to the schemes. Most challenger banks go via another competitor, which is a terrible way. [396]

Crowdbnk wrote that the internet was opening up opportunities for new entrants to provide financial services with low sunk costs.[397] However, Clive Maxwell stressed the continued importance of a branch network, stating "despite the fact that internet and even mobile access to personal current accounts has increased very rapidly over the past few years […] if you want to have a large-scale presence you need a large-scale branch network to go with it".[398]

167. Retail banking is characterised by high market concentration and substantial barriers to entry. The limited switching between providers can be seen as a symptom of this. There is insufficient market discipline on banks to reduce prices and improve service. This lack of competition, compounded by generally low levels of customer understanding of financial products and services, is an important reason why banks can sustain poor standards of conduct and do not seem to feel the same pressure to respond to reputational damage as would be the case in many other industries.


168. The FSA noted in written evidence that a lack of knowledge and information acted as a further barrier to effective competition:

    Asymmetries of information and knowledge between consumers and providers and the fact that infrequent purchases and barriers to switching reduce the ability of customers to exercise market discipline via consumer choice.

The complexity of many banking products makes assessing their quality difficult. Martin Taylor referred to "gigantic information asymmetry in retail banking" where "the customer knows a fiftieth as much about the product as the person selling it to them does".[399] This is partly attributable to a lack of financial literacy in the population. Clive Maxwell spoke of "consumers who find it difficult to understand the products and the services that they are being offered".[400]

169. As a result of information asymmetries, the FSA said that "there is greater potential for customers […] to be exploited in financial services than in other sectors of the economy".[401] This can apply even in ostensibly competitive markets. In Chapter 2 we gave an example of confusing terms for mortgages. The ABI told us that fee structures for investment banking are often so complex that supposedly "sophisticated" corporate customers can be confused:

    even large and sophisticated companies have entered into a complex series of transactions (often with a simple underlying intent), but where the risks have not been fully understood and where the immediate profit for banks on the derivative component(s) of the transaction is unclear—and may be large.[402]

The Association of Corporate Treasurers explained that cross-selling of investment banking products adds to the opacity of pricing:

    The "bundling" of services by banks such that they "price for the relationship" means that, while a company may be separately invoiced for particular services, it actually has little idea what it is really paying for any particular service.[403]

170. Cross-selling is, of course, not restricted to investment banking. Lord Turner told the Treasury Committee that the free-in-credit current account was "essentially a loss leader, [...] a classic loss leader, or at least a low return leader", which banks provided in order to "get hold of a relationship on which they can then sell other products".[404] In Chapter 2, we described the mis-selling of often bundled retail products such as interest rate swaps and PPI. Dominic Lindley told the Commission that the typical pay-out rate for PPI was "between 11 per cent and 25 per cent for a PPI, compared with a motor insurance pay-out rate of around 80 per cent".[405] A properly functioning market would have driven out such poor value.

171. Peter Vicary Smith told us that "the reason why there is a need for greater literacy is in part because the products that are presented are needlessly complicated".[406] Antonio Simoes, Head of UK Retail Banking, HSBC, acknowledged that it took "an hour and a half" to read the terms and conditions for a current account.[407] Referring to interest rate swaps, Abhishek Sachdev explained that there was nowhere for SMEs to go for advice on a complex product: they were sold to unsuspecting customers on "an execution only basis".[408] Clive Maxwell told us:

    I am not yet convinced that banks are sufficiently focused on delivering the sorts of products and services that their customers really want, as opposed to finding ways to charge them for things that they do not necessarily want.[409]

172. Customers are often ill-placed to judge the value of banking services that they are offered. Banks have incentives to take advantage of these customers by adding layers of complexity to products. A good deal of the innovation in the banking industry makes products and pricing structures more complex, hindering the ability of consumers to understand and compare the different products. Regulators and banks need to ensure that information provided is crystal clear to enable comparison and choice.

Incentives to pull in the wrong direction


173. Earlier in this chapter, we noted that the implicit taxpayer guarantee provided to bank creditors creates incentives for banks to pursue financial returns founded on high leverage. However, their liability is limited to the size of their investment while the upside is potentially unlimited. This encourages shareholders to advocate increased leverage in search of growth in times of economic buoyancy. John Kay noted that these incentives are particularly strong in banks, where leverage can act to limit shareholders to a very small proportion of bank liabilities:

    If we look at our banks they are unique among large companies in that the equity shareholders in reality only provide 2 per cent or 3 per cent of the capital of the business in many cases.[410]

Professor Kay likened the interest of such shareholders in banks to that of an option holder in a non-financial company, being prepared to risk their investment for the upside the additional gearing provides. Professors Black and Kershaw noted that it was rational for shareholders to encourage managers to "bet the bank",[411] particularly if they thought that they were smart enough to get out before the ensuing crash. As a result, Professor Kay suggested, shareholders are "not the best people to control" bank risk-taking.[412]

174. Some banks told us that shareholders had put pressure on management to increase leverage. RBS told us that "in some instances investors pressed for what were arguably unsustainable levels of return, creating pressure to increase leverage and take on additional risk".[413] Douglas Flint told the Treasury Committee that:

    there was a great deal of pressure coming from shareholders who were looking for enhanced returns and were pointing to business models that have, with hindsight, been shown to be flawed and in particular very leveraged business models and saying, "You guys are inefficient. You have a lazy balance sheet. There are people out there that are doing much better than you are", and there was tremendous pressure during 2006/2007.[414]

Professors Black and Kershaw explained that pursuing a risky strategy was in accordance with bank directors' responsibility to shareholders:

    For managers whose are required to promote the success of the company for the benefit of the shareholders they comply with their duties if they increase the banks risk profile at the expense of the ultimate non-adjusting creditor—the state.[415]

175. Incentives to pursue leveraged short-term growth conflict with concepts of "stewardship" roles of shareholders focused on the long-term interests of the company. This clash is exacerbated by the reduction in the average holding period for shares, shifts in the profile of UK share ownership away from long-term investors in fundamentals,[416] and pressure on investment fund managers to generate short-term returns.[417] As Sir David Walker summarised, there was a widespread desire for shareholders to take "more long-term views [...] in line with the [...] the stewardship code", but this "will not happen overnight, and it may never happen".[418] This may reflect the distinction between the underlying investors in a pension fund or a collective investment, and the institutional investors and asset managers whose own incentives and remuneration structures may diverge from the long-term interests of the ultimate beneficiaries. These issues are explored in further detail in Chapter 7. Shareholders also exercised inadequate oversight of the conduct of business standards within banks. They ignored concerns raised about widespread mis-selling of PPI. Helen Weir of Lloyds Banking Group said that she could not recall PPI selling standards ever being raised by shareholders.[419]

176. Shareholders are ill-equipped to hold bank boards to account. In particular, institutional shareholders have incentives to encourage directors to pursue high risk strategies in pursuit of short-term returns and ignore warnings about mis-selling. Nonetheless, shareholder pressure is not an excuse for the reckless short-termism witnessed over recent years. Boards and senior management have shown a considerable capacity to ignore shareholders' interests when it has suited them.


Audit and accountancy

177. Auditors are intended to provide checks and balances in the financial system. In evidence to the House of Lords Economic Affairs Committee in 2011, a representative of Hermes Investments said that "audit and accountancy are absolutely fundamental to the integrity of our capital markets and the good governance of our companies".[420] However, that Committee concluded that "the complacency of bank auditors was a significant contributory factor" in the financial crisis.[421] Evidence collected by the Commission pointed to the existence of potential conflicts of interest that meant that, at best, auditors did not act as the last line of defence against banks' questionable reporting on their own businesses and, at worst, they were cheerleaders for it.[422]

178. Various reasons for a tendency towards insufficient challenge have been suggested. The FSA noted a tendency for auditors to take a narrow, box-ticking approach of assessing whether transactions are "clearly inconsistent with accounting standards" rather than applying professional scepticism.[423] Hans Hoogervorst, Chairman of the International Accounting Standards Board (IASB), told the Commission that auditors tended misguidedly to rely on regulators to identify problems:

    auditors do their work in a world where everybody thinks that the situation in the world is hunky-dory [...] I think that the auditors were relying on the regulators to take care of going concern, to tell you the truth. That's a reason why they were not so very critical. I think they need to be more critical. [424]

This problem was exacerbated if auditors and regulators failed to communicate. Andy Haldane drew attention to the conflicts created by the accounts qualification system:

    One of the problems that auditors face at the moment, particularly when evaluating the solvency position of banks, is that they have to reach a rather binary judgment on whether to qualify the accounts or not. That puts them in a rather invidious position, because were they to qualify the financial accounts of a bank, it would almost certainly trigger a run.[425]

In addition, some respondents suggested that the conflicts of interest created by the cross-selling of consultancy services by auditing firms further reduced incentives to expose poor practice.[426]

179. Auditors are required to work within the framework of the accounting system. Since 2005, use of International Financial Reporting Standards (IFRS), which have been adopted into EU law, has been mandatory for the consolidated accounts of publicly-listed companies.[427] Several witnesses told us of a desire for consistent application of IFRS that might have led to an overly simplistic and rigid approach at the expense of professional judgement.[428] In a recent report, the FSA noted:

    in some complex transactions structured to achieve a particular accounting treatment, auditors did not always appear to be willing to robustly challenge key—and at least debateable—accounting judgments made by management, which were fundamental to the transaction. Sometimes there is little evidence that the audit firm has discussed with its client whether the overall accounting presentation of the transaction, as constructed, was appropriate. In some cases, auditors appear to apply only a weaker test of whether or not something is clearly inconsistent with accounting standards. In our view, this approach is not likely to result in high quality reporting or auditing.[429]

Evidence submitted by a consortium of investors threw doubt on the ability of IFRS compliant accounts to be consistent with the 'true and fair' principle.[430] Martin Taylor expressed concern that the mandatory use in valuing assets of the incurred loss model, which had been widely interpreted as implying that default has to occur before provision can be made for the likely loss, was not consistent with prudent accounting.[431]

180. The valuation of certain financial instruments on a "fair value" basis under IFRS has been singled out for criticism, though its defenders argue that there is no realistic alternative when up-to-date valuations of assets are required.[432] Fair value is generally obtained by marking to market (valuing it at its current market price), which can be difficult if there is no liquid market in the type of asset held, or to model (valuing it at a price determined by a financial model). This enables unrealised profits to be booked and, potentially, fed through to dividend and bonus pools,[433] arguably creating incentives for banks and bankers to concoct elaborate schemes to artificially inflate asset values.[434] In a speech in 2011, Andy Haldane explained the pro-cyclical effects of fair-value accounting:

    In sum, accounting rules in general, and fair value principles in particular, appear to have played a role in both over-egging the financial upswing and elongating the financial downswing. They have tended to over-emphasise return in the boom and under-emphasise risk in the bust. That is not a prudent approach. Indeed, it is a pro-cyclical one. We need accounting rules for banks which are crisis-neutral, valuation conventions for all seasons.[435]

181. Auditors and accounting standards have a duty to ensure the provision of accurate information to shareholders and others about companies' financial positions. They fell down in that duty. Auditors failed to act decisively and fully to expose risks being added to balance sheets throughout the period of highly leveraged banking expansion. Audited accounts conspicuously failed accurately to inform their users about the financial condition of banks.

Rating agencies

182. The credit rating agencies were "essential cogs in the wheel of financial destruction".[436] During our investigation of the failure of HBOS, several witnesses admitted to taking glowing references for dubious assets at face value.[437] The failure of the rating agency model derives from the inherent conflict of interest whereby rated companies pay for their own ratings. As a result, ratings agencies had incentives to underestimate the riskiness of assets. A representative of Moody's told the Treasury Committee that rating agencies would compete for business on the basis of generous ratings:

    you had what is so-called rating shopping where underwriters would approach different rating agencies and, to the extent that one or two rating agencies were not in a position to achieve the rating desired, they would not work with that rating agency.[438]

183. Recent research suggests that exposure of this problem has not led to its eradication.[439] In an article in The Financial Times, Arturo Cifuentes said that the ratings agency sector was little changed since the crisis:

    The fact remains that five years after the onset of the subprime crisis, the rating agencies still control the fixed-income market. Far worse, the three agencies that dominated the market before the crisis (S&P, Moody's, and Fitch) still do so.[440]

A European Securities and Markets Authority report found that while progress had been made in "integrity, transparency, responsibility and good governance" credit rating agencies "have not sufficiently embedded in their organisations those changes necessary to address the concerns about the conflicts inherent in [their] business models".[441]

184. It is widely held that credit rating agencies have business models founded on a conflict of interest, whereby in most cases they are paid by those who issue the financial products of which the agencies purport to be the dispassionate assessors. The industry also contains a barrier to entry which reduces competition in the ratings industry: issuers are often unwilling to deal with a number of agencies, and many issuers believe that investors will want ratings by the well-known firms. This entrenches the position of the three main agencies who continue to dominate the market, notwithstanding their chequered forecasting record. There have been insufficient signs of change. This would matter less if the agencies were viewed as just another source of opinion, but their ratings have come to enjoy an unwarranted status. This is because rating agency scorings offer a convenient shorthand to describe risk, not just for market participants, but particularly for the regulators.


185. The UK tax system, in line with international norms,[442] has long incentivised the use of debt over equity by allowing interest to be deductible against profits, while dividends are distributed from post-tax profits. Professor Mike Devereux, Director of the Oxford University Centre for Business Taxation, told us that there was "no good reason why debt and equity should be treated differently by the tax system as a matter of principle" and that the bias "creates a number of distortions" in the behaviour of banks.[443]

186. Sir Mervyn King explained the tax bias in favour of debt could act to encourage high leverage:

    One of the arguments that banks can put forward for saying that it is good for the shareholders to have more leverage is that there is a tax advantage to use debt finance rather than equity.[444]

The International Monetary Fund submitted that, while there was a link between the tax bias towards debt and leverage, it could not conclusively be said that that had a material effect on banks' leverage across the world in the lead-up to the financial crisis. However, the IMF suggested that this did not mean tax should be dismissed as an issue, because "even small changes in the leverage of very large banks could have a large impact on the likelihood of their distress or failure, and hence on the likelihood of financial crisis".[445] Professor Mike Devereux concurred that, while tax was not the main cause of "the sharp increase in leverage that led to the crisis", it was "certainly there as a factor".[446]

187. Ernst and Young highlighted that the tax system was not "aligned to incentivise similar behaviour to regulation", meaning that complying with regulations could "penalise banks from a tax perspective".[447] Andy Haldane argued that the tax system was pulling in the opposite direction to regulatory capital requirements, meaning that regulators were "trying to induce banks to do something that the tax system at present provides a disincentive to do, which is to raise extra equity".[448] He added that a more neutral tax system would "lessen the burden on this complex regulation".[449]

188. The tax bias that incentivises companies to favour debt over equity did not by itself cause the financial crisis. The scale of its impact on the incentives for banks to become highly leveraged is unclear. But, at the very least, having a tax system that encourages banks to take on more risk certainly does not help. The more forces that are pulling in the wrong direction, the more difficult it is to design the regulation required to restrain them.


189. In our First Report we noted the effectiveness of the banks in lobbying politicians and warned that this could have pro-cyclical effects:

    The characteristics of financial crises and the nexus between banks, politicians and regulators together pose fundamental challenges for the design and implementation of structural separation. Any framework will need to be sufficiently robust and durable to withstand the pro-cyclical pressures in a future banking cycle. [...] Politicians need to face up to the possibility that they may prefer those siren voices to the precautionary approach of regulators, particularly if, once again, it appears that banks are performing alchemy.[450]

Adam Posen observed that UK Governments have tended to reserve special support for the banking industry, describing it as a "fetish":

    Governments who promote particular industries [...] tend to distort political decision-making and tend to distort the incentives for that industry to behave. Every major economy has its protected industry that gets romanticised. In the US it's usually agriculture; in France it's agriculture; in Japan it's rice farming, even though they don't eat rice that much any more; in Germany it's automobiles—pick your country, pick your poison. In the UK, however, and this is where it makes it worse, the fetish is banking.[451]

Sir Mervyn King told the Treasury Committee "not to expect too much from regulators" not least because of the political constraints they operate under:

    The real problem that any of them would have faced was that if they had said to banks in the City before 2007, "You are taking big risks", they would have been seen to be arguing against success. [...] they would have been confronted with this massively difficult task of actually persuading people, persuading you, that they should have been taking action against institutions that looked very successful and highly profitable. [...] Any bank that had been threatened by a regulator because it was taking excessive risks would have had PR machines out in full force, Westminster and the Government would have been lobbied, it would have been a pretty lonely job being a regulator.

190. The favourable treatment of banking by regulators and governments has not merely been the consequence of smooth lobbyists seducing naive politicians. The economic growth and tax revenues promised by a booming sector over the relatively brief political cycle dazzled governments around the world. This encouraged excess and undermined regulators. Public anger with bankers has now dimmed this effect, but its possible revival in calmer economic times, when bankers are off the front pages, should remain a deep concern.

Insufficient downsides


191. It is a source of great public bafflement and anger that so few individual bankers seem to have paid any personal price despite the widespread damage that has been caused by the various failures and scandals. In theory there is a wide range of sanctions that could be applied, including actions from within banks such as loss of job or clawback of pay, and official actions such as public censure, fines, industry-wide bans from serving as company directors and, in relation to certain offences, even jail. Official sanctions, impeded by the lack of individual accountability described earlier in this chapter, have been so rare as to be largely meaningless as a deterrent. The sanctioning of individuals has instead largely been left to weak and inconsistent internal mechanisms in banks.


192. Although it is true that many bankers have lost their jobs since the financial crisis, most of them played little direct part in causing the problems. Some senior executives who were responsible for failures have been seen to resign as a direct consequence of those failures, while not acknowledging any personal fault. Earlier in this chapter we considered the accountability firewall at work regarding responsibility for LIBOR manipulation. Furthermore, many individuals who held senior positions in areas where failures occurred remain in post or in similar positions elsewhere in the financial system. For example, of the 18 executive and non-executive directors who were on the RBS board when it had to be rescued in 2008, 8 of them were still on the boards of financial services firms as of the end of 2011.[452]

193. It was only after the publication of our Report on the failure of HBOS that James Crosby left two senior roles: as non-executive director of Compass Group, the world's largest catering company, and an advisory role at private equity firm Bridgepoint.[453] Lord Stevenson relinquished his last remunerated position in the financial services sector in the week he gave evidence to the Commission.[454] As we noted in our report on HBOS, the FSA appeared to have taken no steps to establish whether these individuals are fit and proper persons to hold Approved Persons status.[455] We understand that this work is now being undertaken as part of the regulators' forthcoming report on the HBOS failure.

194. Some bankers have faced financial losses as a result of the failures, through bonuses being cut or through the fall in the value of bonuses held as equity.[456] However, such losses cannot be viewed as a meaningful sanction in most cases. Banking was a one-way bet, where participants had the chance to make large short-term gains by taking risks and bending rules, but where if things went wrong the costs fell on others. As a result of the historic lack of deferral or clawback clauses in banker pay, many have been able to hold on to the vast rewards that accrued during the good times—whether deservedly or not—so even having gambled and lost they remain significantly in pocket. Fred Goodwin may have lost much of the value of any RBS shares he held, but over his eight years as CEO of the bank he earned a cumulative salary of £8.3 million and £12.4 million in bonuses (a large portion of which he would have received in cash, or shares which he later sold),[457] and left with an annual pension worth £342,000, even after giving up a portion under public pressure.


195. Regulators have the power to impose significant penalties on individuals who engage in inappropriate behaviour, unlike banks, who can generally only impose penalties if they are within the terms of their contracts with their employees. The prospect of public censure, significant fines or being banned from the industry could provide a meaningful downside to balance the significant upsides in banking. However, there has been negligible use of such sanctions against individuals.

196. In relation to the financial crisis, despite the ample evidence of widespread failures of management, leadership and risk control, the FSA has only brought a single case against an individual: the former head of Bank of Scotland's corporate division, Peter Cummings, who was fined £500,000 and given a lifetime ban from the industry.[458] Our Fourth Report, on the failure of HBOS, concluded that:

    downfall cannot be laid solely at the feet of Peter Cummings. While his personal responsibility for some staggering losses should properly be recognised, significant and indeed disastrous losses were also incurred by other divisions, whose heads have not been held personally accountable in the same way. [...] The Commission considers it a matter for profound regret that the regulatory structures at the time of the last crisis and its aftermath have shown themselves incapable of producing fitting sanctions for those most responsible in a manner which might serve as a suitable deterrent for the next crisis.[459]

The FSA intended to pursue an industry ban on Johnny Cameron, a former RBS executive, but ended their investigation in 2010 when he voluntarily agreed not to work in the financial services industry again.[460] No other directors or senior executives from any UK banks which failed or needed public support have faced any regulatory sanction. The only other senior executive from a large UK bank to face any enforcement action in recent years was John Pottage, a former UBS wealth management executive, whose fine for misconduct was overturned by tribunal in 2012.[461]

197. Investigation and potential enforcement action against individuals is still ongoing in relation to the manipulation of LIBOR,[462] but it seems likely that this will be restricted just to those individuals directly involved with falsifying the figures rather than extending to the more senior executives who had responsibility for the systems and controls which failed. As Tracey McDermott, the FSA's head of enforcement, told us:

    What you do in an investigation is follow where the lines of inquiry take you. You do different investigations in different ways, but typically you will start working up from the bottom to get through the process, and see which direction you are pointed in, in terms of who are the people with responsibility and who are the people who are aware. You expect people who you are interviewing—if they think that it is not their fault, but that somebody more senior was actually responsible—to point you in that direction. The questions you ask are around where the trail takes you, and where this stops.[463]

In the case of UBS, this approach to investigations meant that the executives in charge of the investment bank at the time manipulation took place were not even interviewed by the supervisor and said they learned of the events only on reading about them in the press.[464]

198. Similarly, no members of senior management of a major bank has faced enforcement action over PPI mis-selling:

    no senior management in financial services organisations had enforcement action taken against them for the mis-selling of PPI. The only senior management individual to have enforcement action taken against them for mis-selling unsecured loan PPI was the chief executive of a furniture retailer (Land of Leather). Not a single individual senior banking executive has ever had enforcement action taken against them for presiding over the mis-selling of products.[465]

Tracey McDermott clarified that "it is actually seven individuals in relation to PPI, but they are not [from] large banks".[466]

199. Delegation and organisation distance acts to protect senior management from culpability for conduct failures within their chains of responsibility:

    Decisions were made further down the chain of command. If the delegation was appropriate (i.e. to an appropriately qualified person with suitable resources etc) the more senior individual will not be at fault. In conduct cases (although perhaps less so in prudential matters) the decisions which are made which impact adversely on customers may sometimes be made a long way from the top of the organisation and the senior management and/or board currently have relatively little visibility of them.[467]

200. The virtual absence of official sanctions against individuals, despite the widespread failures, has contributed to a loss of public trust in banking which even the banks themselves acknowledge. HSBC told us:

    Inability to pursue individuals for behaviours deemed wholly unacceptable by society but for which there are no sanctions available has contributed to deterioration in public trust in the industry.[468]

Virgin Money added that "The failure to take action against individuals adds to public concern that directors and senior executives of large banks seem to be "above the law".[469]


201. The largest fine imposed on a bank for mis-selling PPI was £7 million on Alliance and Leicester, a tiny proportion of the revenue they gained from selling this highly profitable product. Clive Briault, former Managing Director of Retail Markets at the FSA, told us that such fines were accepted as a cost of business:

    I would certainly go along with a view that, purely as a matter of economics, if you compare the level of the fine against the big profitability of the business, you could chose to regard it as a cost of doing business, yes.[470]

Mr Briault went on to acknowledge that fines levied for PPI mis-selling were largely unrelated to the profits made from those sales:

    it was not linked very closely to the amount of profit made through the particular activity. That was just as true in all other activities as for PPI. That was by no means unique to PPI. [471]

202. The fines enforced by the FSA on Barclays, UBS and RBS are by some distance the largest in their history.[472] However, such punishments are unlikely to have any impact on individuals, who have little or no loyalty to the firm and are primarily motivated by short-term revenue generation. Michael Foot told us:

    As far as the other group is concerned—those individuals who do not care in the sense that they put a higher priority on short-term success and are prepared to walk the line or run the risk of punishment—all I can say is that the regulator has very few carrots so the sticks have to be as large as possible. These people tend not to care about the size of the fine on the firm; they care only about fines on them and serious damage to their capacity to earn money and maintain their reputation going forward. That is where the thing will have to focus as best it can.[473]


203. The distorted incentives in banking are nowhere more apparent than in the asymmetry between the rewards for short-term success and costs of long-term failure for individuals. Many bankers were taking part in a one-way bet, where they either won a huge amount, or they won slightly less and taxpayers and others picked up the tab, even if some individuals paid a large reputational price. Many have continued to prosper while others, including the taxpayer, continue to foot the bill for their mistakes. There have been a few isolated instances of individual sanction, but these have rarely reached to the very top of banks. This sanctioning of only a few individuals contributes to the myth that recent scandals can be seen as the result of the actions of a few 'rotten apples', rather than much deeper failings in banks, by regulators and other parts of the financial services industry.

204. Many of the rewards have been for activities previously undertaken within a partnership model, a model under which a more appropriate balance between risk and reward exists. The return of these activities to partnership-based vehicles such as hedge funds could help redress the balance and is to be encouraged.

106   Ev 887 Back

107   Tacitus, Treason Trials, Financial Crisis, Tiberius and Astrology, Deaths of Drusus and Agrippina, Book VI, (A.D. 32-33) Back

108   William Stearns Davis, The Influence of Wealth in Imperial Rome (MacMillan,1910). Stearns Davis also wrote of questionable conduct by the "sage, sly, unscrupulous" negotiatores, or money-lenders, of ancient Rome. Emboldened by political influence, some would switch between acting as tax collectors and lenders, taking advantage of vulnerable municipal authorities by charging extortionate rates of interest. Such "extraordinary opportunities for ill-gained and easily gained wealth", he claimed, resulted in a society where the ruling classes gauged everything in terms of money, "a cult of Mammon which has no counterpart in history". Back

109   Edward Chancellor, Devil Take the Hindmost: a History of Financial Speculation (Plume, 1999), p 13 Back

110   Emilios Avgouleas, The Mechanics and Regulation of Market Abuse (OUP, 2005) Back

111   Michael D. Bordo, The Crisis of 2007 :The Same Old Story, Only the Players Have Changed, remarks prepared for the Federal Reserve Bank of Chicago and International Monetary Fund conference; Globalisation and Systemic Risk, 28 September 2007 Back

112   J.K. Galbraith, The Great Crash 1929 (Penguin, 2009, first published 1955) Back

113   Carmen M. Reinhart and Kenneth Rogoff, This time is different: eight centuries of financial folly (Princeton University Press, 2009) Back

114   Ev 1552 Back

115   EQ 126 Back

116   Philip Augar, Reckless: the Rise and Fall of the City, 1997-2008 (Vantage, 2010), p 228 Back

117   "The Great Moderation", speech by Ben Bernanke to the Federal Reserve, 20 February 2004 Back

118   Gary B. Gorton, Misunderstanding Financial Crises: Why We Don't See Them Coming (OUP, 2012), p4 Back

119   Parliamentary Commission on Banking Standards, First Report of Session 2012-13, HL Paper 98 and HC 848 (hereafter cited as First Report), para 75 Back

120   Q 1011 Back

121   Deirdre (Donald) N. McCloskey, Does the Past Have Useful Economics? American Economic Association Journal of Economic Literature, Vol. 14, No. 2 (June1976), pp 434-461 Back

122   Carmen M. Reinhart and Kenneth Rogoff, This time is different: eight centuries of financial folly (Princeton University Press, 2009), p16 Back

123   See, for example, United States Financial Crisis Inquiry Commission, Final Report, January 2011, Chapter 3 Back

124   Ibid. p 44 Back

125   Ibid. p 45 Back

126   "A history of hubris and flawed hypotheses", The Financial Times, 13 January 2013 Back

127   Raghuram G. Rajan, Fault Lines, (Princeton University Press, 2010), p 1 Back

128   Gerard Caprio, Jr., Asli Demirgu¨ç-Kunt and Edward J. Kane, The 2007 Meltdown in Structured Securitisation, World Bank Policy Research Paper 4756, October 2008 Back

129   Ev 1537 Back

130   Q 626 Back

131   Q 4416 Back

132   FR Ev 103 Back

133   Charles Calomiris, Banking crises and the rules of the game, in Wood et al (eds.), Monetary and Banking History: Essays in Honour of Forrest Capie (Routledge 2011) Back

134   Charles W. Calomiris, Banking Crises Yesterday and Today, PEW briefing paper no.8, 2009 Back

135   Treasury Committee, Ninth Report of Session 2012-13, Budget 2013, HC 1063, para 146 Back

136   "Fannie and Freddie no model for UK housing", The Financial Times, 25 March 2013 Back

137   Ev 1293 Back

138   1980 Institutional Investor article cited in the appendix to a statement by C.T. Conover, Comptroller of the Currency, to the US House of Representatives Committee on Banking, Finance and Urban Affairs, 1984 Back

139   Appendix to a statement by C.T. Conover, Comptroller of the Currency, to the US House of Representatives Committee on Banking, Finance and Urban Affairs, 1984 Back

140   Parliamentary Commission on Banking Standards, Fourth Report of Session 2012-13, 'An accident waiting to happen': The Failure of HBOS, HL Paper 144, HC 705 (hereafter cited as Fourth Report) Back

141   Geoffrey Elliott, The Mystery of Overend & Gurney (Methuen, 2006), p 10 Back

142   Charles Calomiris, Banking Crises and the Rules of the Game, NBER Working Paper No. 15403, October 2009 Back

143   Charles W. Calomiris, Banking Crises Yesterday and Today, PEW briefing paper no.8, 2009 Back

144   Charles Calomiris, Banking Crises and the Rules of the Game, NBER Working Paper No. 15403, October 2009 Back

145   Ibid. Back

146   First Report, para 17 Back

147   Q 4596 Back

148   Treasury Committee, Eighth Report of Session 2012-13,Appointment of Dr Mark Carney as Governor of the Bank of England, HC 944, Ev 50  Back

149   Q 453 Back

150   Treasury Committee, Nineteenth Report of Session 2010-12, Independent Commission on Banking, HC 1069, para 22 Back

151   Bank of England, The $100 billion question speech, Andy Haldane, 30 March 2010 Back

152   Q 128 Back

153   Q 4554 Back

154   Treasury Committee, Ninth Report of Session 2009-10, Too important to fail-too important to ignore, HC 261-i, para 22 Back

155   Communities and Local Government Committee, Seventh Report of Session 2008-09, Local authority investments, HC 164-i, para 152 Back

156   Audit Commission, Risk and return English local authorities and the Icelandic banks, March 2009, p 28 Back

157   Q 4595 Back

158   Ev 1513 Back

159   First Report, para 104 Back

160   Qq 4375-4376 Back

161   Board of Governors of the Federal Reserve System, Brookings Institution Conference on Structuring the Financial Industry to Enhance Economic Growth and Stability speech, Governor Daniel K. Tarullo , 4 December 2012 Back

162   "Banking Economies of Scale", Wall Street Journal Davos Live blog, 25 January 2012 Back

163   Q 3701 Back

164   Q 3700 Back

165   Q 314 Back

166   Q 330 Back

167   DQ 349 Back

168   Q 2620 Back

169   Q 3774 Back

170   Q 4017 Back

171   Bank of England, On being the right size speech, Andy Haldane, 25 October 2012 Back

172   Q 647 Back

173   Ev 834 Back

174   Q 4554 Back

175   Q 3783 Back

176   Q 1881 Back

177   Q 3703 Back

178   HQ 213 Back

179   Ev 1403 Back

180   Q 3623 Back

181   Salz review: An independent Review of Barclays' Business Practices, April 2013, para 8.32 Back

182   Q 3796 Back

183   Q 3784 Back

184   Q 3778 Back

185   Fourth Report, para 53 Back

186   Ibid. para 64 Back

187   Salz review: An independent Review of Barclays' Business Practices, April 2013, paras 2.11-2.13 Back

188   Ibid. para 7.12 Back

189   Ibid. para 8.35 Back

190   Ibid. para 2.17 Back

191   Q 3699 Back

192   Ev 1454 Back

193   Ev 1138 Back

194   John Maynard Keynes, The General Theory of Employment, Interest and Money, (Palgrave Macmillan, 1936) Back

195   DQ 20 Back

196   Ibid. Back

197   Ibid. Back

198   Transcript of interview with former HBOS employee in relation to enforcement case against Mr Cummings, 9 July 2010 Back

199   EQ 155 Back

200   EQ 171 Back

201   Fourth Report, para 75 Back

202   EQ 155 Back

203   C Ev 130 Back

204   Foresight, The Future of Computer Trading in Financial Markets-An International Perspective, 2012 Back

205   Bank of England, The race to zero speech, Andy Haldane, 8 July 2011 Back

206   GQ 6 Back

207   G Ev 33 Back

208   GQ 12 Back

209   GQ 12, see also G Ev 29 - 31 Back

210   Ev 1137 Back

211   G Ev 31 Back

212   G Ev 41 Back

213   GQ 12 Back

214   Ev 1124 Back

215   DQ 91 Back

216   DQq 99, 109 Back

217   DQ 71 Back

218   Ev 1366 Back

219   Ev 986 Back

220   Uncorrected transcript of oral evidence taken before the Treasury Committee on 4 July 2012, HC (2012-13) 481-i, Qq153, 3969 Back

221   Ibid. Q158 Back

222   Ibid. Q164 Back

223   Treasury Committee, Second report of Session 2012-13, Fixing LIBOR: Some preliminary findings, HC 481, paras 34 and 38 Back

224   UBS, FSA Final Notice, 19 December 2012 Back

225   UBS, CFTC Order, 19 December 2012 Back

226   Ibid. Back

227   Q 2093  Back

228   Q 2059 Back

229   Q 2041 Back

230   Ev 1320 Back

231   Ev 1564 Back

232   Letter from Bob Diamond to Andrew Tyrie MP, 28 June 2012, Back

233   Treasury Committee, Second Report of Session 2012-13, Fixing LIBOR: Some preliminary findings, HC 481, paras 185-193 Back

234   Q 3907 Back

235   Qq 3908-3909 Back

236   Ev 1464 Back

237   Ev 1463 Back

238   JQq 485-6 Back

239   Ev 1056 Back

240   Q 4381 Back

241   "Banks must show they are now very different creatures", BBA Blog, 19 April 2013, Back

242   See Annex3. Back

243   Barclays 2007/08 figures exclude BGI as a discontinued activity. LBG figures for 2007 and 2008 represent the sum of Lloyds TSB and HBOS. We have added back one off pension credits of £910m and £250m in 2010 and 2012 respectively. RBS figures are on a pro forma or managed basis. The Barclays figures partly reflect the additional costs from the acquisition of parts of the Lehman Brothers business in September 2008. The LBG figures partly reflect the merger with HBOS in 2009. Back

244   Salz review: An independent Review of Barclays' Business Practices, April 2013, para 11.29 Back

245   EQ 164 Back

246   C Ev 151 Back

247   Ev 935 Back

248   Ev 1082-1083 Back

249   C Ev 154 Back

250   Q 3194 Back

251   Q 2946 Back

252   Ev 102 Back

253   Ev 1453  Back

254   Ev 1538 Back

255   Q 166 Back

256   Ev 1538 Back

257   Ev 1377 Back

258   Ev 1224 Back

259   Ev 966 Back

260   JQ 3 Back

261   JQ 276 Back

262   JQ 292 Back

263   Ev 966 Back

264   Q 623 Back

265   Qq 414-415 Back

266   Ev 886 Back

267   Ibid. Back

268   Ev 1455 Back

269   Ev 1310 Back

270   Salz review: An independent Review of Barclays' Business Practices, April 2013, para 8.21 Back

271   Ev 1289 Back

272   "UBS banker gets $26m 'golden hello'", BBC, 14 March 2013, Back

273   Q 1996 Back

274   DQ 91 Back

275   DQ 159 Back

276   Ev 886 Back

277   DQ155 Back

278   DQ 78 Back

279   DQ 76 Back

280   Genesis Ventures report on Barclays Wealth America seen by the Commission and quoted in "Exposed: The regime of fear inside Barclays - and how the boss lied and shredded the evidence", The Mail on Sunday, 20 January 2013 Back

281   DQ 81 Back

282   J. M. Coates and J. Herbert, "Endogenous steroids and financial risk taking on a London trading floor", Proceedings of the National Academy of Sciences of the United States of America, vol. 105 no. 16, pp 6167-6172 Back

283   DQ 99 Back

284   Ev 935 Back

285   Ev 1323 Back

286   Ev 1454 Back

287   Ev 886 Back

288   Q 1 Back

289   Ev 1454 Back

290   Ev w 889 Back

291   Anthony Sampson, Anatomy of Britain, (Hodder and Stoughton,1962), p 348 Back

292   Ev 1289; see also Ev 737. Back

293   Ev 1424 Back

294   Ev 1036 Back

295   Ev 886 Back

296   "How traders trumped Quakers", The Financial Times, 6 July 2012, Back

297   Ev 1109 Back

298   Ev 1126 Back

299   Ev 927 Back

300   Qq 2381-2399 Back

301   Ev 1287 Back

302   Genesis Ventures report on Barclays Wealth America seen by the Commission and quoted in "Exposed: The regime of fear inside Barclays - and how the boss lied and shredded the evidence", The Mail on Sunday, 20 January 2013.  Back

303   JQ 4 Back

304   Ev 1342-1343 Back

305   Barclays, FSA Final Notice, 27 June 2012; UBS, FSA Final Notice,19 December 2012; RBS, FSA Final Notice, 6 February 2013 Back

306   UBS, FSA Final Notice,19 December 2012; RBS, FSA Final Notice, 6 February 2013 Back

307   Q 4026 Back

308   DQ 74 Back

309   Ev 1631 Back

310   Ev 1169 Back

311   Ev 986 Back

312   Ev 1170 Back

313   For example, DQq 177, 383,581 Back

314   Ev 943 Back

315   IIA Position Paper, The three lines of defense in effective risk management and control, January 2013 Back

316   "The trouble is, regulators are idiots", Guardian banking blog,10 May 2012, Back

317   DQ 676 Back

318   Q 2271 Back

319   DQ 123 Back

320   DQ 581 Back

321   DQq 699-701 Back

322   DQ 45 Back

323   DQ 773 Back

324   Goodhart's original formulation was "any observed statistical regularity will tend to collapse once pressure is placed upon it for control purposes". See Charles Goodhart. "Problems of Monetary Management: The U.K. Experience". Papers in Monetary Economics (Reserve Bank of Australia) I, 1975. Back

325   DQ 49 Back

326   DQ 50 Back

327   DQ 408 Back

328   Q 331 Back

329   Q 4409 Back

330   Ev 1040 Back

331   Q 4412 Back

332   Q 4413 Back

333   Q 1011 Back

334   G20, London Summit - Leaders' Statement, 3 April 2009 Back

335   FSA Board Report, The failure of the Royal Bank of Scotland, December 2011, p 264 Back

336   FSA Board Report, The failure of the Royal Bank of Scotland, December 2011, p 264 Back

337   Written evidence from Andrew Bailey to the Treasury Committee, March 2013, p 10, Back

338   FSA, Speech by Sir Howard Davies to the Foreign Banks and Securities Houses Association Conference, 29 November 2001 Back

339   BQ 55 Back

340   Q 213 Back

341   Ev 1464 Back

342   Q 638 Back

343   Q 639 Back

344   Q 3853 Back

345   EQ 49 Back

346   Bank of England, The dog and the Frisbee speech, Andy Haldane, 31 August 2012  Back

347   Q 48 Back

348   Q 976 Back

349   EQ 99 Back

350   The Banking Review, Competition in UK Banking: A Report to the Chancellor of the Exchequer, March 2000, para 2.14 Back

351   Ibid. para 4  Back

352   'It is time to end the oligopoly in banking', The Financial Times, 8 May 2012, Back

353   EQ 58 Back

354   Q 334 Back

355   Q 2327 Back

356   Q 2328 Back

357   BQ 3 Back

358   Q 4556 Back

359   Salz review: An independent Review of Barclays' Business Practices, April 2013, para 2.14 Back

360   Ev 1112 Back

361   Ev 1457 Back

362   JQ 15 Back

363   JQ 176 Back

364   EQ 61 Back

365   Q 3851 Back

366   Q 4490 Back

367   EQ 109 Back

368   Q 3855 Back

369   Seventh Report from the Treasury Committee, Session 2010-12, Financial Regulation: a preliminary consideration of the Government's proposals, HC 430-II, Q 8 Back

370   Ev 1205 Back

371   Q 2321 Back

372   Q 2361 Back

373   FR Ev 186 Back

374   Independent Commission on Banking, Final Report, September 2011, p167 Back

375   OFT, Review of the personal current account market, January 2013, p27 Back

376   Ev 1427 Back

377   OFT, Review of the personal current account market, January 2013, p4 Back

378   Independent Commission on Banking, Final Report, September 2011, p 167 Back

379   IQ 10 Back

380   Q 194 Back

381   Independent Commission on Banking, Final Report, September 2011, p 171 Back

382   Ev 1221 Back

383   OFT, Review of the personal current account market, January 2013, p101 Back

384   FQ 63 Back

385   Q 2333 Back

386   Treasury Committee, Nineteenth Report of Session 2010-12, Independent Commission on Banking Standards, HC1069-II, Ev 64 Back

387   Ibid. Back

388   Q 349 Back

389   Q 2321 Back

390   Q 2322 Back

391   Q 167 Back

392   Q 134 Back

393   FQq 1-3 Back

394   Q 234 Back

395   FSA, A review of requirements for firms entering into or expanding in the banking sector, March 2013 Back

396   Q 2370 Back

397   F Ev 92 Back

398   Q 3074 Back

399   Q 365 Back

400   Q 3075 Back

401   Ev 1039 Back

402   G Ev 22 Back

403   G Ev 26 Back

404   Treasury Committee, Ninth Report of Session 2010-11, Competition and choice in banking, HC1069-II, Q48 Back

405   JQ 40 Back

406   JQ 23 Back

407   DQ 509 Back

408   AQ 112 Back

409   Q 3070 Back

410   Q 344 Back

411   Ev 831 Back

412   Q 344 Back

413   Ev 1324 Back

414   Treasury Committee, Ninth Report of Session 2010-11, Competition and choice in retail banking, HC 612, Qq 833-835 Back

415   Ev 831 Back

416   See, for example, The Kay Review of UK Equity Markets and Long-term Decision Making: Final Report, July 2012 Back

417   Treasury Committee, Ninth Report of Session 2010-11, Competition and choice in retail banking, HC 612, Q 834 Back

418   Q 3628 Back

419   Q 67l Back

420   Economic Affairs Committee, Second Report of Session 2010-12, Auditors: Market concentration and their role, HL 119, para 2 Back

421   Ibid. para 167 Back

422   HQq 188 -200 Back

423   FSA and FRC, Enhancing the auditor's contribution to prudential regulation, DP10/3, FSA/FRC, June 2010, Para 3.41 Back

424   HQ 92 Back

425   HQ 108 Back

426   See, for example, Ev 1381,1443 Back

427   H Ev 235 Back

428   HQq 133, 309, 389 Back

429   FSA and FRC, Enhancing the auditor's contribution to prudential regulation, DP10/3, June 2010, para 3.41 Back

430   H Ev 236 Back

431   Q 2947 Back

432   H Ev 75, 112, 304, 314 Back

433   HQq 36-7, 103 Back

434   H Ev 262 Back

435   Bank of England, Accounting for Bank Uncertainty speech, Andy Haldane, 19 December 2011 Back

436   National Commission on the Causes of the Financial and Economic Crisis in the United States, The Financial Crisis Inquiry Commission: Final Report, January 2011, p xxv, Back

437   BQ 179, 270-276 Back

438   Uncorrected transcript of oral evidence taken before the Treasury Committee on 7 March 2012, HC (Session 2010-12) 1866-ii, Q240 Back

439   Cynthia E. Clark and Sue Newell, "Institutional Work and Complicit Decoupling across the U.S. Capital Markets: The Work of Rating Agencies", Business Ethics Quarterly, Vol 23 (2013), Issue 1 Back

440   "Get technical to fix rating agencies", The Financial Times, 4 March 2013, Back

441   "ESMA requires further improvements by CRAs", European Securities and Markets Authority press release, 18 March 2013, Back

442   HQ 5 Back

443   HQ 1 Back

444   Q 4581 Back

445   H Ev 256-257 Back

446   HQ 6 Back

447   H Ev 184 Back

448   HQ 114 Back

449   Ibid. Back

450   First Report, para 78 Back

451   JustBanking, Keynote speech, Adam Posen, 19 April 2012, Back

452   " Where are they now? What became of the 18 Royal Bank of Scotland directors who oversaw its demise?" Scotland on Sunday,,11 December 2011 Back

453   "Ex-HBOS chief Sir James Crosby asks to return knighthood", BBC News, 9 April 2013, Back

454   B Ev 258 Back

455   Fourth Report, para 135 Back

456   "Lloyds bank claws back £1.5m bonuses from directors", The Guardian, 20 February 2012, Back

457   RBS Annual Reports, Back

458   Peter Cummings, FSA Final Notice, 12 September 2012 Back

459   Fourth Report, para 134 Back

460   "FSA Statement on Johnny Cameron", FSA Press Notice FSA/PN/081/2010,18 May 2010, Back

461   "Statement: Mr John Pottage", FSA statement, 23 April 2012, Back

462   Q 2284 Back

463   Q 2263 Back

464   Q 2233 Back

465   Ev 1463 Back

466   Q 3002 Back

467   Ev 1056 Back

468   Ev 1126 Back

469   Ev 1438 Back

470   JQ 191 Back

471   JQ 193 Back

472   Ev 1052 Back

473   EQ 55 Back

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© Parliamentary copyright 2013
Prepared 19 June 2013