Parliamentary Commission calls for sweeping changes to UK banking

August 2013 | FEATURE | BANKING & FINANCE

Financier Worldwide Magazine

Custodial sentences for reckless senior bankers, the dissolution of the government owned Royal Bank of Scotland (RBS) into separate ‘good’ and ‘bad’ banks, and the lengthy deferral of bonus pay for bankers. These are just a few of the sweeping changes to the UK banking sector that have been recommended to the government by the Parliamentary Commission on Banking Standards.

In mid-June the cross party Commission finally published its long awaited report which looked into the professional standards and culture of the banking sector in the UK, concluding that “serious regulatory failure” contributed to the industry’s and, by extension, the country’s wider economic collapse.

The report also suggested that regulators need to be “close enough” to the sector, and have a detailed enough understanding of businesses, to take “swift decisions” based on up-to-date information, rather than belated actions with the benefit of hindsight. The Commission was mandated by Chancellor George Osborne in 2012 to examine a perceived decline in standards and practices in the British banking sector after a number of scandals hit in quick succession in the wake of the financial crisis.

The London Interbank Offered Rate (Libor) fixing scandal in particular saw three banks – Barclays, RBS and UBS – fined more than £1.6bn by both British and American regulators. The banks were fined for their manipulation of Libor, which underpins the global financial system and other interest rate benchmarks. According to the Commission, there had been deep lapses in standards at many British banks and the numerous recent scandals had exposed “shocking and widespread malpractice” throughout the sector.

In response to these revelations, many of which caused a great deal of public uproar and recrimination, the report returned with a number of recommendations designed to restore respectability and accountability to the banking sector. The Commission felt that one way in which the notion of personal liability can be reinstated into the sector would be by creating a new criminal offence under which any senior bankers who are found guilty of reckless misconduct in the future could face criminal sanctions, including custodial sentences.

Not only did the 571 page report call for the imposition of criminal sanctions against what it deemed to be irresponsible bankers, it also proposed a number of other recommendations. Notably, bonus pay for bankers should be deferred for up to 10 years and subsequently cancelled if a banker behaves inappropriately. The report also states that there should be more transparency on what activities executives are responsible for. This would be achieved by allocating to senior bankers clear, personal responsibilities, with a legal liability placed on the individual to demonstrate they have done all that is reasonably required of them and that they have acted with integrity. Throughout the document the Commission also advocated tighter rules surrounding bankers’ pay and greater competition among British banks. This proposed transparency for employees in the financial sector, the Commission argues, would make any future regulatory punishments easier to dole out to bankers suspected of reckless activity or negligence.

The report and its recommendations have drawn praise from both analysts and politicians alike, Prime Minister David Cameron described the work carried out by the commission as “excellent”. While extolling the virtues of the report’s findings, Mr Cameron also criticised the last Labour government for presiding over a “boom and bust” economy and doing “absolutely nothing” to strengthen financial regulation. The Treasury department also welcomed the report, calling it “a very impressive piece of work”.

Although the recommendations of the Commission are not legally binding, the report is expected to influence regulators. Accordingly, responsibility will now rest with the government to decide which of the Commission’s suggestions it wishes to incorporate into the Banking Reform Bill which is due later this year. However, it is possible that some of the reforms recommended by the Commission could be lifted out of the report and introduced as separate bills in their own right.

Problems

Clearly, the most striking and media friendly of all of the proposals set forth by the Commission is the suggestion that in the futuresenior bankers could face a prison sentence for their perceived negligent behaviour. The report urges Mr Osborne to oversee the creation of a new criminal offence for the vaguely defined crime of “reckless misconduct in the management of a bank”.Under the proposed new scheme, senior level bankers would have to prove that they were not responsible for any future rule breaches in order to avoid sanctions, rather than forcing regulators to make a case against them.

Additionally, as and when senior level bankers move jobs they will be required to sign off on all the risks they are leaving for successors. If any of these remaining risks are not highlighted, they will lose deferred bonus money, which could be held back for as long as a decade. Some members of the Commission had suggested that the implementation of such a plan would put an end to some bankers relying on the so called ‘Murder on the Orient Express’ defence. This is a popular argument which insists that because numerous people within an organisation were party to a decision, no one individual can be held chiefly to blame.

As we have seen with the Libor scandal and other incidents, there have been clear examples of staff in British banks operating recklessly. However, the recommendation by the Commission that the government create a new criminal offence to combat recklessness is a distressing one. Despite the populist nature of the new recommendation, in reality it would be a very complicated act to enforce. In the majority of cases it is difficult to draw a clear distinction between a banker making a poor business decision in good faith – or via sheer incompetence – and a banker acting recklessly.

While there may certainly be a case made for increased regulation within the sector, as the era of the Labour government’s ‘light touch regulation’ increasingly seems to be at an end, it is imperative that the implementation of new rules and regulations are carried out in an appropriate manner. Although some lay the blame for the British financial crisis at the feet of the banking sector, there must be a clear distinction drawn between wilful, reckless activity designed to cause harm, and errors in judgement. Professor Roger McCormick, director of the sustainable finance project at the London School of Economics believes that changing the law in Britain would not be easy. “All we have is a recommendation from a parliamentary commission. It’s an interesting idea, but legally difficult territory to go into,” he said. “What test of reckless conduct would there be? Would it be akin to the criminal offence of recklessness in manslaughter? It’s difficult imposing a standard of behaviour that would not apply to other enterprises. But it may well survive as there’s currently public demand for some sort of criminal sanction to apply. The reason the law is as it is, is because it’s far from easy drawing up a new law.”

Furthermore, the authors of the report themselves do not seem entirely convinced of the feasibility of the proposed new criminal offence. Entitled “A new criminal offence?” the section of the report that outlines the scheme seems to suggest a lack of conviction within the Commission. Indeed, the report suggests that while “there is a strong case in principle for a new criminal offence of reckless misconduct in the management of a bank” it would be very difficult to obtain a conviction for such an offence.

The imposition of new criminal sanctions against individuals operating within the banking sector, as well as the controversial deferral of employee compensation packages, may have a long lasting negative effect. These new regulations could easily lead to the industry experiencing a brain drain which could damage the profitability of the British banking sector. It is entirely plausible that very talented people within the British financial community may walk away from the sector to jobs which fall outside the glare of the general public, and are less stringently regulated. The financial reforms proposed by the Commission are unlikely to drive British banks to seek greener pastures abroad; however, banks in global markets could easily retreat to other financial centres where they are unlikely to encounter similar regulations.

Conclusions

In all likelihood, the criminal sanctions proposed by the Commission are designed to act more as a deterrent than as an enforceable law. Prosecutors will struggle to prove irresponsibility in an industry in which risk taking is part and parcel of the business. By the same token, the chance of a large number of banking executives being prosecuted for reckless conduct are very slim, owing to the practical challenges associated with identifying a single guilty party among members of staff who make decisions on risk taking every day.

The recommendations contained within the Commission’s report are drastic, yet not without their supporters. The proposals, which are also intended to help the industry take steps to foster better long-term planning and improve risk management, have been described as “sensible” by Mark Boleat, policy chairman at the City of London Corporation. Whereas Boris Johnson, the mayor of London, embraced the report’s focus on governance, Mr Johnson also noted that it is only right that wrongdoing in the industry should be “rooted out and punished”.

However, Mr Johnson also rightly emphasised the importance of the City remaining competitive with other global financial centres. Ultimately, overregulation and unnecessarily stringent financial constraints will hurt the City’s global standing and the nation’s economy. To that end, the proposed deferral of some senior banker’s compensation packages for up to 10 years, as outlined by the Commission, seems excessive. However, some limited restrictions around the issuing of financial incentives would seem prudent. As large sections of the UK are still being crushed under the weight of austerity, the financial sector would be wise to appear sympathetic to the travails of the nation – particularly as the general public’s confidence and trust in the financial industry over the years since the financial crisis are seemingly at an all time low.

Organisations such as the Chartered Institute of Personnel and Development (CIPD) have come out in support of the proposed regulations and are at pains to point out that they do not feel that the report is tantamount to ‘banker bashing’. Yet, at times, the report itself does not seem to be a study of the banking system; in many ways it appears to be a report on how best to assign blame to and make pariahs of bankers. By advocating populist policies, the Commission appears to be joining the lynch mob, looking for someone to blame for the country’s economic ills. While it is clear that in the build-up to the financial crisis, some banker’s operated irresponsibly and outside of their remit, it does not seem prudent to damage the sustainability and profitability of the UK’s biggest export industry – especially when the country is still only a small way down the road to full economic recovery.

Richard Summerfield