Banking StandardsWritten evidence from Raymond Sturmer

Introduction

An article in the September 2012 issue of “Governance and Compliance”, the magazine of the Institute of Chartered Secretaries and Administrators (ICSA), featured the setting up of the Commission and listed what expectations there are of it and that responses to a number of questions would be welcome. A copy of that article is attached in order to follow my responses.1

The writer is an Associate of the Institute of Bankers and a Fellow of ICSA and worked for 38 years in an international French bank in the City of London starting as a junior and attaining the status of general management. The experience embraced most areas of banking and included, for some time, frequent contact with the Bank of England and with many senior bankers from a wide range of banks as a result of being secretary of an association of international bankers. The experience included both corporate business and banking for wealthy individuals and stockbroking in a subsidiary of the French bank. Although retired, the writer has followed financial affairs quite closely through the media, including the professional magazines of the institutes mentioned.

The responses (by reference to numerotation of the article)

1. There has been a deterioration in the standards of professionalism in London and the United Kingdom. Having been regarded as higher than those of many other countries, it is probable that standards are now no better and may be worse than in some.

The UK had a very high reputation internationally for probity, skill and dynamism which manifested itself by attracting foreign banks from all over the world (over 500 at one time). The initial effect of this was to encourage a great and creative diversity of services and products which benefitted customers, the profitability of the banks and increased invisible exports enormously.

However, almost inevitably some of the less ethical practices from some countries crept into the UK mindset. With the vast increase in competition more and more risky practices evolved and less and less care was taken over the analysis of the dangers. At the same time the creation of international giants of industry required the banks to make bigger and bigger loans and other transactions, sometimes in an effort to retain those customers or through fear of not being able to compete, especially against the largest US, Japanese and European banks. The ability of management to control the organisations in the way they had been able to earlier became more and more stretched. Indeed, I can recall thinking that some banks were so large that they were unsupervisable and that regulators would not be able to control them as envisaged.

There was also a problem for supervision in that the former informal guidance from the Bank of England was challenged by more legalistic foreign banks and they were enabled to adopt practices and risks which the Bank would previously have been able to discourage, if not prevent. Banking Acts enshrined the powers of the Bank of England and subsequently the “Big Bang” instituted regulators governed by regulations, and in both cases the opportunity to challenge the regulator or to write business before the regulator had an opportunity—even if it could not object—to consider the impact of it became evident.

The inauguration of hedge funds re-inforced the short-termism which was becoming a factor in the markets. They tended to trade in large amounts and began “investing” in companies with a view to a quick turnaround, having no interest in the long-term futures of their purchases or of the industry or of the UK’s interests. This was analogous to the “asset stripping” which became prevalent in the late 1960s and 1970s which was often centred around, and confined to, property values. The later version was mainly speculative.

2. The consequences for consumers, whether retail or wholesale have been:

Their interests have been largely ignored as witnessed by the unfolding of numerous scandals of mis-selling.

Products have been designed for the benefit/profitability of the institutions.

Institutions have furthered their own interests and profitability without regard to the interests of the consumer or the risks they have encouraged the consumers to take.

The introduction of call centres has distanced the consumer from the institutions (or vice versa) and has diluted the expertise which was formerly available to customers. Many bank branches do not have a manager with broad experience and many decisions are referred to regional centres to which customers do not have ready access.

Individual rewards have encouraged over-selling and caused bank staff to be oblivious to the consequences of their actions.

Banks, encouraged by the financial press, have tempted consumers to seek increasing returns in unsuitable products, the customer having no appreciation of (or being able to appreciate) what risks are embedded.

Customers feeling disadvantaged and unenterprising unless they were taking “advice” from bank personnel or the press.

Conditions being applied to products and services which the average customer was unable to understand and the more onerous ones not being explained.

The media continually encouraging customers to seek out new opportunities and to switch providers and products so that there were ample occasions for confusion, for acquiring the wrong sort of product or service, and of customers not necessarily improving their positions as leap-frogging by providers would often leave them worse off with a new provider as their old one quickly overtook their new one.

Even supposedly “professional” customers turned out not to understand what they were doing and were certainly not enlightened by providers. Local authorities were caught in the lending to foreign banks; corporates were led into taking out hedges which cost fortunes; and investment managers bought into sub-prime packages which proved costly. Caveat emptor maybe, but today’s mores tend towards protections which did not exist in the past.

3. It is evident that banks have lost much trust and are seen as pariahs, not to say as dishonest. The public does not know to whom to turn for sound advice. This may not matter for the corporate and sophisticated customers but for the private customer he or she generally thought they would receive impartial advice. This idea is no longer believed.

[ As an aside, so-called Independent Financial Advisers (IFAs) have a very mixed reputation and are themselves often guilty of over-selling and of encouraging customers to be economical with the truth when it comes to eg self-certification of salaries when applying for mortages. Many IFAs are not qualified to deal with the complex products and services on offer and which change overnight.]

The recent revelations regarding LIBOR fixing, the PPI controversy and money laundering among the major banks have done nothing to inspire confidence. There is a widely held view that banks have been significant contributors to the economic woes of the last four years and that they have not accepted their culpability. The fact that they have received billions of pounds to support them grates with many when they compare the sufferings of the unemployed and those on low incomes, especially when compared with the excessive rewards of the senior executives of banks.

It will take many years for this negative attitude to disappear.

4. Reasons for the problems are varied. Some are:

The dissociation between the risk takers and the shareholders. That is to say that those taking the risks had no capital at stake. They earned large rewards without suffering the consequences of their errors. Shareholders, even institutional ones, would have little opportunity to see what was happening on a day-to-day basis, but belatedly have become more influential in respect of the rewards of executives. Perversely, there is sometimes a reluctance to hold down rewards as there can be an uplift factor for everyone if they are rising. Shareholders should expect the profits to be distributed fairly so that the capital is rewarded as it should be for the risks being taken, and generally better than for those taking the risks on the books. Dividends have been slashed or suspended while rewards for executives have continued at a generous level.

Peer pressure. It has been common for many years that if a “profitable” opportunity appears to arise all competitors will follow to benefit from the same product or service. Further, if one bank is seen to be making huge profits from an activity, the management and the shareholders of others will wish to participate as well and risks can be ignored, or at any rate overlooked, in the dash to make money.

The creation of highly technical products, very often not fully understood, has been a significant cause of problems. This has been exacerbated by mis-selling and ignoring counter-party risks.

The impossibility for directors and management to control operations and staff in organisations which are so vast, where markets are so fast moving and where innovation is rife. Pre-approval of the way a bank operates would be seen to be stifling innovation and dynamism so the oversight of much of what goes on is post facto and too late, or by the time the situation is fully understood the product/service has burgeoned too much and sometimes the apparent profitability appears too attractive to call a halt. Internal audit work can be useful if those to whom it is submitted are prepared to act upon it even if it affects profitability.

The same is true for external auditors who try to have a “snap-shot” of the organisation and to make a judgment on whether the controls are adequate. There is little chance that they will detect major problems until they have occurred and the damage is done.

Ratings agencies have created illusions of the standing of many banks and the risks attached to products. Doubtless their efforts are valiant and offer some insight into the risk of doing business with countries or banks or companies. However, the users of such ratings have often been blinded by those ratings and have suspended independent judgements, or in many cases lack the means to make independent appraisals. Many decisions have been taken on the basis of the rating given by these agencies, when the rating should only be a guide to which own judgement is added. Often the rating of the issuer, buyer or borrower is preferred over the risk of the product itself.

Competition is certainly a factor, first because of peer pressure as mentioned above and, second because margins and profitability are so slim that they do not represent the true risk/reward ratio and banks do not build up sufficient reserves.

The culture of the banks has declined over the last twenty or thirty years. Staff destined for promotion were expected, though less among the foreign banks who often benefited from employing qualified staff from the indigenous banks, to have climbed the ladder with a sound understanding of what banking was about and who would be expected to have obtained the qualifications offered by the Institute of Bankers which were generally of a technical nature rather than certificates in marketing. (I may be prejudiced here but the evidence of call centre staff who have a narrow range of knowledge has been obvious).

The relationship between retail and investment is a factor to the extent that the latter tends to be fast moving, risk orientated and highly rewarded, creating a two-speed organisation. Further losses in the investment bank will be detrimental to the bank overall, although there are supposed to be risk weightings related to the quantum of capital available. But capital is not ring-fenced, so there is an argument for splitting the two activities, each having its own capital base. The difficulty for major corporate is that they want one-stop banking and an investment banking product or service may be used in association with its retail requirement, e.g hedging currency or foreign exchange risk.

Almost instantaneous communication has been effective in the ability to trade quickly and anywhere in the world. On the other hand, and it is unlikely this will be reversed, decisions have to be made in an instant with little time for reflection and analysis. This may not be significant in respect of, say, foreign exchange transaction but may be more so when, say, legal opinion is needed and lawyers are under pressure to give fast advice, or when an assessment of a counter-party is necessary.

5. This is a difficult problem to resolve as the organisation of banks is so intertwined, the products so complex, the amounts of the risks being taken are so large, the multinational companies are so demanding and the controls are so problematic to put in place without hampering the innovation, the speed of responses required, and the service needed by the customers.

It could be argued that the retail and investment sides of banks could be split off entirely, or that the investment banking side should be more highly capitalised (which would affect the profitability) or that banks should not deal in some retail products, eg domestic mortgages, but that would not necessarily have stopped packages of such products from being securitised and sold on. It could be that the seller of some products should be expected to retain some responsibility for the risk once they have been sold on—this might actually deter such activities. When syndicated loans were pre-eminent, the merchant banks and investment banks would try to pass off all the risks to the participants. This was sometimes successfully resisted, giving the “lead manager” an interest in ensuring that the risk was identified and covered as much as possible.

11 November 2012

1 Not printed.

Prepared 24th June 2013