Reining in banks towards better governance

Responsible bankers have a duty to see to it that they don’t get into the sort of over-drive which might bring them to grief and… perhaps also into jails

Banks are an essential outfit to the overall economic infrastructure. They are vital to the normal functioning of the economy. They run the country’s payment system which enables bills to be paid and wages to be settled with regularity. They help businesses carry out their investments into existing and new ventures; they help households buy up houses in which to live. There is no denying that banks have become a centrepiece without which the entire economic system will come to a grinding halt. For all these reasons, it is necessary to keep them running in good shape.

Bankers need not develop a blind spot at the macro-level

There are occasions however when banks become the source of great anxiety. This is when, chasing their own individual pursuits, they pay scant attention to the overall situation in which they evolve. The financial crisis of 2007 which hit the western world in particular was evocative of such a situation. After the crisis hit, most observers noticed that banks had been lending too much, pushing up economies into unsustainable over-drive. To finance their excessive lending, banks were busy borrowing funds heavily on a hand-to-mouth basis. But the problem was that borrowing on such a huge scale was not being undertaken by them to finance real things pertaining to clients, investors, etc.

They were in fact borrowing from each other to finance each other to support their dealings in an ever-increasing volume of complex and obscure financial instruments, some sort of a continuous bet they had been taking on each other. On the other hand, the amount of their borrowing from this money market was so large that the little amount of capital they held relatively to their market borrowing was wafer-thin. It needed a small piece of bad news to get across to wipe out the entire capital of a bank, leaving the burden of bankers’ enormous misjudgement to be picked up by depositors and governments exposed to facing the consequences otherwise of a widespread crumbling of the economy. This is exactly how the crisis came.

Political and Social consequences of bank failure

Events came in rapid succession. In Britain, it began with Northern Rock, a bank which experienced a run on its market borrowing in 2007. It would have sunk with all the bad implications this had for the British economy and the concerned banks, had it not been for the Bank of England stepping in to bail it out before the foreseeable crash. By 2008, the same woes hit the Royal Bank of Scotland (RBS). With assets worth £2.2 trillion, RBS was the biggest bank both in Britain and in the world. Like other big banks of the West, its capital was totally inadequate to the situation. It was salvaged with the UK government injecting in it capital amounting to £45.5 billion, representing an 81% stake in the bank’s shareholding. Had it not been for timely intervention to salvage these and other systemically important banks, the British economy could have nose-dived instantly along with its banks. Despite all these efforts to set right the banking sector, the economy went into recession and has not recuperated yet from the down cycle it entered into at that time. Millions were made jobless as vast swathes of the economy sank along with sharply falling demand for goods and services. Many businesses either went down entirely or had to shrink in order to survive in an environment of lost confidence.

Identical scenarios played out in Europe and America. People were forced to survive on the dole or on sharply reduced earnings. Severe welfare cuts had to be imposed affecting millions. Millions of jobs were lost with no clear sign of when the economic crisis will really be over and how to engineer back a stable environment of growth. In many of the affected countries, over 50% of the young population is jobless to this day without a clear perspective about when and how normalcy will be restored.

Just as banks can launch economies into prosperity, they can become the root cause of extensive distress imposed on populations which have nothing to do with the banking decisions which were the primary source of economic disruption. Yet, for having wrought such an extensive amount of damage to the livelihoods of so many millions of individuals, there are few only of the major decision-makers in the concerned banks who have been sanctioned. Some have been sentenced in America for insider dealing for relatively short terms. Some juniors have been cast up in more preponderant roles than their jobs would qualify them for and it is they who have been taken up for trial or imprisoned for over-trading or rigging markets. In contrast, several of the top jobholders in banks have quietly walked away after handsome bonus payments or they have been asked to relinquish their jobs by way of internal restructuring.

Top jobholders in banks cannot escape public accountability when it misfires

That the top brass of banking establishments have been immune from serious prosecution and they have not been called upon so far to account for their faulty judgements which led to the overall banking debacle, has caught the attention of British lawmakers. This happened particularly in the context of a series of scandals hitting British banks recently. Since the financial crisis began, several British banks have been unable to rescind large payouts to either senior executives or midlevel traders who carried out risky activity that led to major losses at the financial institutions. The latter have managed to shift the blame to others at lower levels or limited sanctions to taking internal actions within the confines of the financial institutions.

On Wednesday last, a British parliamentary commission on banking standards created last year in response to a series of scandals, outlined plans for greater responsibility over how British banks were managed. The plans convey the idea that senior managers of banks cannot escape public scrutiny and accountability for their serious errors and omissions. Some of the recommendations will be incorporated into proposed banking legislation that is expected to come into effect next year. In a number of recent scandals, including the attempted manipulation of the London interbank offered rate (LIBOR), top executives at some of Britain’s leading banks denied knowing that the activities had taken place. In the circumstances, the British politicians in the banking commission have called for assigning specific responsibilities to banks’ senior manager in a bid to increase accountability when problems arise.

“Recent scandals have exposed shocking and widespread malpractice,” said Andrew Tyrie, a British politician who leads the banking commission. “Taxpayers and customers have lost out. The economy has suffered. Trust in banking has fallen to a new low.” The British lawmakers have laid out a series of reforms aimed at improving accountability at the country’s largest banks. They recommend an overhaul of the set-up intending to criminalize misbehaviour by senior bankers. Central to the overhaul are recommendations to make it a criminal offence to recklessly mismanage local financial institutions. By aiming at senior executives for criminal charges related to financial mismanagement, British lawmakers said the new legislation would force bankers to be less cavalier with risky trading and lending activities.

“The fact that recklessness in carrying out professional responsibilities carries a risk of a criminal conviction and a prison sentence would give pause for thought to the senior officers of UK banks,” the British banking commission said.

Let us not invite troubles here

It is at once stunning and refreshing that banking would have crossed the boundaries of safety and responsibility to such an extent even in as liberal an environment as the British banking system that lawmakers have not stopped short of recommending a prison term at the highest level for faulty misjudgement by top level bankers in the UK. Do we have to follow suit by writing up in our law books similar sanctions to keep the top management of banks, including boards, from tilting over into irresponsible conduct at public expense?

Recent events implying that certain local bankers would not have undertaken the required amount of due diligence before staking significant amounts of money lost into untrustworthy hands overseas seem to indicate that there is a need to ring the alarm bell. Canons of safe lending are known to good bankers who could make a stray misjudgement on occasion but if the book is overwritten with a host of irrecoverable bad debts, there would be reason enough to consider whether deterrents of the sort being recommended for the UK will not prove effective to rein in our banking system towards making sounder judgements with depositors’ money.

However, as the crisis of 2007 showed, the rot had been building up in the West for years before it exploded in the face of governments. Therefore, it is important to ensure that there are no build-ups requiring the ultimate sanction against individuals due to acts of imprudent financial behaviour, both in banking and systemically important non-bank financial institutions of the country.

We cannot afford to place misfits in key positions in our financial institutions who, having done the mischief, would have left the institutions financially impaired for a long time to come. Governance of financial institutions is a comprehensive issue and one that has enduring effects on them over time. It must be said for the record that the majority of our bankers have not conducted themselves in the past with the type of rash over-confidence that has led to wide scale banking failure in so much of the West. This is a track record worth preserving for the good standing of the country and responsible bankers have a duty to see to it that they don’t get into the sort of over-drive which might bring them to grief and… perhaps also into jails, as it is being contemplated in the case of the UK.

* Published in print edition on 21 June 2013

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