19 Jun 2013 02:31pm

Radical proposals for better banking

Senior bankers who are found guilty of reckless behaviour in carrying out their professional responsibilities could face jail if recommendations in the long-awaited banking standards report are implemented

They would also face confiscation of the remuneration they received during the period of reckless behaviour.

Individual incentives have not been consistent with high collective standards, often the opposite

“Too many bankers, especially at the most senior levels, have operated in an environment with insufficient personal responsibility,” the Parliamentary Commission on Banking Standards says in the 571-page report.

“Top bankers dodged accountability for failings on their watch by claiming ignorance or hiding behind collective decision-making. They then faced little realistic prospect of financial penalties or more serious sanctions commensurate with the severity of the failures with which they were associated.

“Individual incentives,” it adds, “have not been consistent with high collective standards, often the opposite.”

The commission, which is headed up by Andrew Tyrie MP, was set up last July by chancellor George Osborne in the wake of the Libor rigging scandal. The report is its fifth and is a distillation of the 9,198 questions it asked during 80 evidence sessions and the 5,000 pages of witness statements it had to wade through.

The commission concludes that the UK banking sector’s ability to perform its role in supporting the real economy has been “eroded by a profound loss of trust born of profound lapses in banking standards”.

In coming up with its recommendations for change, it identified five objectives:

  • To make individual responsibility in banking a reality, especially at the most senior levels
  • To reform governance in banks to reinforce each bank’s responsibility for its own safety and soundness and for the maintenance of standards
  • To create better functioning and more diverse banking markets in order to empower consumers and provide greater discipline on banks to raise standards
  • To reinforce the responsibilities of regulators in the exercise of judgement in deploying their current and proposed new powers
  • And to specify what role government and parliaments should play now and in the future.

As far as making individual senior bankers more responsible for their actions, the commission proposes a new framework which would include a senior persons regime where key responsibilities within banks would be assigned to specific individuals, a licensing regime which would apply to other bank staff whose actions could seriously harm the bank, and a single set of banking standards rules.

There would also be a new remuneration code which would apply to senior people and licensed banking staff. “Remuneration,” the commission believes, “has incentivised misconduct and excessive risk-taking, reinforcing a culture where poor standards were often considered normal.

“Many bank staff have been paid too much for doing the wrong things, with bonuses awarded and paid before the long-term consequences become apparent. The potential rewards for fleeting short-term success have sometimes been huge, but the penalties for failure, often manifest only later, have been much smaller or negligible. Despite recent reforms, many of these problems persist.”

The commission suggests that bonuses should be deferred by as much as 10 years and cancelled if a bank has to be rescued by the taxpayer.

The commission wants to see a unified professional body set up by the banking sector to establish a string set of standards and expectations for individuals. It should be funded by the banks and individual membership but remain independent through its forms of governance disciplinary procedures and senior personnel – “no cosy sinecure for retired bank chairmen and City grandees”.

Corporate responsibility

The current reporting standard is “not fit for regulators’ purposes

As for the banks themselves, as well as a fundamental change of culture, their governance needs a complete overhaul. “Both the financial crisis and conduct failures have exposed very serious flaws in the system of board oversight of bank executives and senior management,” the commission says.

“The corporate governance of large banks was characterised by the creation of Potemkin villages to give the appearance of effective control and oversight, without the reality. In particular, many non-executive directors – in many cases experienced, eminent and highly-regarded individuals – failed to act as an effective check on, and challenge to, executive managers.”

The commission calls on the Financial Reporting Council to publish proposals to beef up the nominating procedures for appointing NEDs “designed to address the widespread perception that some ‘natural challengers’ are sifted out by the nomination process”.

As well as their responsibility for overall leadership of the bank. Bank chairmen should have an explicit responsibility for setting standards and providing effective oversight over how they are embedded in the organisation. The most senior NED should assess the chairman’s performance annually, ensure that the relationship between the chairman and the chief executive does not become too cosy, and report his conclusions to the regulator each year.

Clearer lines of accountability need to be established for the assurance of overall regulatory compliance with the chief risk officer, compliance head and the internal audit function reporting to a named individual NED. And there should be better protection for whistleblowers, including enforcement powers for the regulator where whistleblowers have not been properly treated by the bank.

Accounting for regulatory needs

The commission is concerned about the time the profession is taking moving the basis for valuing debt assets to an expected loss model, and urges the FRC to prioritise an early decision in EU negotiations. It says that the current reporting standard is “not fit for regulators’ purposes” and recommends that non-EU mandated regulatory returns be combined, with any other accounting requirements needed, to create a separate set of accounts for regulators.

“This second set of accounts should be externally audited and the commission recommends that a statutory duty to regulators be placed on auditors in respect of these accounts. Where there is a public interest for these accounts to be published, the regulator should have a legal power to direct that they (or where appropriate, abbreviated accounts) are included in the financial statements, alongside a reconciliation to the IFRS accounts.”

The commission also wants to see an enhanced “commentary” upfront in the auditors’ report which discusses key judgment areas, including valuation, risk and remuneration, which are “so crucial to investors understanding of a bank’s business model.

In the past, it says, the auditors’ relationship with bank supervisors has been “dysfunctional”. It recommends giving legislative backing to bolster the relationship and calls on the Bank of England to commission a periodic report on the quality of dialogue between auditors and supervisor.

The commission says that its proposals can do much to enable government, regulators and the industry itself to remedy the shortcomings in banking standards. “The challenge for government is to follow through on the commitment to far-reaching reform,” it says. “The challenge for regulators, in implementing planned reforms and the commission’s proposals, is to give substance to their commitment to a greater exercise of judgment.

“The greatest challenge lies with the banks. It also represents a great opportunity. By making constructive use of the recommendations and by supporting their spirit as well as the letter, the banks can, over a period, earn the respect of the public, and thereafter regain their trust. Everyone can be the beneficiary.

“Implementation of the agenda we have set out for higher standards will lead to an industry which better serves both its customers and the needs of the real economy. It will also further strengthen the position of the UK as the world’s leading financial centre. If implemented, our proposals can change banking for good."

Julia Irvine


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