How banks went from ‘too big to fail’ to ‘too big to nail’

Another week, another series of record banking penalties. JP Morgan, Barclays, RBS, Citigroup and UBS have been fined a total of $5.7 billion by US prosecutors and UK regulators for forex rigging. Barclays was fined the most, with a $2.4 billion penalty the price it paid for refusing to join in when other banks settled in November. In a move which would have been astonishing a few years ago, all but UBS have agreed to plead guilty to US criminal charges.

Meanwhile, over at HSBC the fallout from tax and money-laundering allegations concerning its Geneva private bank continued at last month’s AGM. Having already been subjected to grillings by two parliamentary committees, HSBC top brass found themselves under fire this time from their own investors.

Despite all the furore and embarrassment caused, it is unlikely that the directors of the world’s largest financial institutions are unduly worried about the regulatory consequences of bad behaviour, news of which emerges with monotonous regularity. As a function of corporate capture, they are too big to nail in any meaningful sense and they and the markets know it. And without fundamental changes to both the internal culture of big banks and a tougher regulatory approach to targeting individual directors, there is precious little chance of preventing such scandals from reoccurring.

The scandals that have been tarnishing the industry will inevitably rumble on for a considerable while. Whether any of this will result in senior banking executives being held accountable is highly doubtful. One of the surest indicators of this is to track bank share prices. In his 2012 book The Signal and the Noise, statistician Nate Silver wrote of the difficulty, when making predictions, of distinguishing the pieces of data which really mattered (the “signal”) from the welter of other information available (the “noise”). Well, amidst all the noise of the last couple of months, the signal is the fact that bank share prices scarcely budge when news of the latest scandal or fine emerges. Sometimes the share price will react modestly but generally it is no more than a minor blip, demonstrating that the market does not believe that serious long-term consequences are going to follow. Barclay’s share price increased by over 1 per cent when news of its record breaking fine broke.

The reason for this is that the perception by the markets of scandal in relation to big banks has long since shifted from that of an occasional acute condition to one which is chronic. Rate rigging, mis-selling, sanctions busting, tax evasion, money laundering and even criminal facilitation – these have become facts of life and are priced in. Sure, fines have to be paid. But in the absence of prosecutions – particularly of senior banking officers and directors – such penalties are now simply seen as part of the cost of being in the banking business.

There is a way to change this but it requires two things: action by the banks to reform their internal cultures and address the human factors that lie behind excessive risk-taking and wrongdoing; and action by regulators to target senior individuals rather than the institutions themselves, whose fines and penalties are at present borne by the shareholders.

The response in the banking industry when things go wrong is invariably to address internal systems, changing or adding to the processes. But finance is foremost a human business and the problem is that the culture in the industry has been fundamentally flawed. For too long, the risk-takers have held the upper hand and those responsible for managing risk – both reputational as well as financial risk – have been treated as second class citizens.

Professionalising the industry so that banking, in common with other good professions, nurtures the correct ethos and ethical standards among its practitioners is essential to address this. Such change must start at the top yet, despite the systemic importance of banks, they continue to be stewarded by non-executive directors without the necessary technical competence to get to grips with highly complex products and services and the risks inherent in delivering them across diverse global markets. It beggars belief that in the United States in the post-financial crisis era bank directors need only have a “basic knowledge of the banking industry”. The position is scarcely better in the UK.

The failure by regulators to impose strict competency requirements on directors has resulted in the absence of a meritocracy at the top of the industry and the emergence instead of what looks to many to be a cabal of bank non-executives insulated by a web of big business and establishment connections.

As for governments and regulators, they need to turn their fire on individual executives and directors. How many bankers have been subjected to regulatory action, prosecuted, stripped of the right to be a director let along sent to prison as a result of the financial crisis or recent scandals over manipulation of the forex markets or Libor?

The unfortunate reality is that generally executives walk away scot free and pensions intact while shareholders and consumers are left to foot the bill. Prosecutions or regulatory action against individual directors rather than institutions would help to demonstrate just how serious the consequences are of board-level incompetence and presiding over banks that engage in corrupt or illegal practices.

Governments and regulators already have the necessary powers at their disposal but no one has been willing to use them because there has never been much appetite in the UK to hold senior bankers properly to account for the failings of the organisations they steward. Politicians know that the financial services sector makes both an enormous contribution to the UK economy and controls vast pools of development capital. There is simply no appetite to kill the golden goose, or scare it off to more welcoming climes.

The US may be less enamoured of foreign banks operating on its territory. But its prosecutorial hand too has been stayed. Every enforcement decision is weighed carefully in the balance with prosecutors aware that a sudden withdrawal of one of the world’s largest banks from the US financial system could have frightening consequences. The proliferation of deferred prosecution agreements, where banks pay a hefty fine but avoid criminal charges, has been the result, further encouraging the moral hazard initiated by bank bailouts. While last week’s guilty pleas from banks may appear to be a watershed, no one is suggesting that the banks will lose their US banking licences as a result.

This ultimate lack of accountability was recognised in a recent speech by US senator and former Harvard professor Elizabeth Warren. Arguing for restrictions on the use of deferred prosecution agreements, Senator Warren bemoaned the fact that agreements which were originally devised to deal with low-level individual offenders had been “transformed beyond recognition to create get-out-of-jail-free cards for the biggest corporations in the world”.

In 2008 the world became all too familiar with the concept of “too big to fail”. Eight years on it turns out that the same institutions are “too big to nail”. Unless and until the directors of errant banks are in fear of their pension and their liberty when things go seriously wrong under their watch, nothing will change. And there will be every reason to think the markets have made the correct call about the long-term consequences of bank scandals.

Stephen Platt is a barrister, an adjunct professor at Georgetown University, Washington DC, and author of Criminal Capital: How the Finance Industry Facilitates Crime (Palgrave Macmillan)