Last week, Government published its findings into the failure of HBOS. Fortunately, it won’t happen again – right? Financial reform is on track – correct? Unfortunately not.
“Too big to fail, bail and jail” has summed up the challenge. Capital and accountability have framed the regulatory response. Yet seven years on, banking leverage remains high and accountability low. Sadly, the courage to address either seems lacking.
Capital, accountability and courage. All other issues pale in comparison. Let me take them in turn.
Let’s start with capital – and the leverage it is meant to limit. True, the new Basel III regime tightens up on definitions of banking risk and places an overall cap on gearing. But as currently set, this 3 per cent “leverage ratio” allows bank balance sheets to balloon to 33 times their loss absorbing equity.
At that degree of gearing, a 3 per cent decline in the value of bank assets wipes out 100 per cent of bank capital. A mere 1 per cent decline leaves the institution leveraged 50 times; a 2 per cent decline – 100 times. How confidence- inspiring is that?
Evidently not enough. Some jurisdictions wish to raise the 3 per cent ratio to 4 or even 5. Would that be sufficient? No. Those ratios would translate into bank balance sheets some 20 to 25 times their loss-absorbing equity. Hedge funds, by the way, operate on average at 3 times leverage.
To such top-ups, regulators have added stress testing and a requirement for total loss absorbing capacity (TLAC). Such steps are a poor substitute for capital. Why? For stress testing to be effective, regulators must know which risks to stress and by what degree to do so. They, like the banks they regulate, got it wrong before and will get it wrong again. That is why there is capital. Capital is there not just for the risks we think we understand – it is there for the ones we don’t!
As for TLAC, it rests on two shaky assumptions: 1) that the authorities will have the guts to force losses on debt holders – they didn’t last time; and 2) that at the first hint of trouble, debt and equity holders are going to wait around to find out. Would you?
In short, Basel III is a busted flush. The measures to compensate serve only to confirm this fact – without adequately compensating for its failure.
If capital is vital to the survival of our market system, accountability is critical to its legitimacy. That bankers behaved badly in the run up to the melt-down is old news. But before discussing further, please take a look at the adjacent list of “misdeeds.” It is a lengthy list. It is also a partial one!
And what has been done? Hearings have been held. Commissions have been commissioned. Fines are frequent. Investigations continue. But no bank has lost its banking license. No senior has gone to jail. No management team has been prosecuted.
No board or supervising executive has been financially ruined. Many have kept their jobs, their pensions and their perks. Among those dismissed, few have been banned from the field for the future. As to the fines, they have been paid by the shareholders, not by the perpetrators. Few believe them to be an effective deterrent.
Is there any wonder that the public has lost faith in finance? Restoring accountability is vital to restoring a sense of fairness much less reducing reckless behaviour.
As to progress on this point, I was once hopeful. I am no longer optimistic. I was hopeful because regulators and politicians were making the right noises. Parliament strengthened sanctions for financial wrongdoing. The US Attorney General declared that no bank was too big to jail.
The BoE’s Governor Mark Carney called for “clear consequences, including professional ostracism” for failure to live up to the necessary standards. More recently the Chancellor, George Osborne, declared “there is no trade-off between high standards of conduct and competitiveness.”
But, of course, actions speak louder than words. And actions to date fall short of what was both needed and possible. Making misdeeds into criminal offences is helpful but enforcing the laws already on the books can and must happen first. And the fact is that laws have been broken but law-breaking has not touched senior management.
In the US, “deferred prosecution agreements” are the order of the day. Such “settlements” are announced with fines and fanfare but the detailed evidence behind such agreements has been hidden from the public eye.
Similarly, existing tools have sat untouched. The UK’s Financial Services Authority and its successor have long had the ability to oust bank management and board by striking them off the “approved persons list.” They have not done so to any visible extent. How can this be?
Look again at the litany of wrongdoing. Either senior management knew what was going on or they didn’t. If they knew, they were complicit. If they did not, they were incompetent.
Meanwhile, the chairman of Europe’s largest bank remains in situ – despite having been on the board since 1995; despite having signed off on the acquisition of Household Finance; and despite having had oversight of tax entangled subsidiaries in Switzerland and money laundering units in Mexico. Evidently he meets the new “fit and proper” standards.
Clearly, the authorities have been unwilling or unable to stand up to the politicians who in turn have been unwilling to stand up to the banking lobby. “Why” is no doubt a subject for another article.
Here I should like to stress capital, accountability and courage. For unless we address leverage we cannot have confidence in the resilience of the system. Without better behaviour we cannot have faith in the market that underpins it.
Without penalising the perpetrators and their seniors, we will not get better behaviour. And without greater courage from policy makers and regulators, we will get none of the above and more of the same. When timidity triumphs, the taxpayer pays. Alas, timidity is the order of the day.
Robert Jenkins is a Senior Fellow at Better Markets and a former member of the BoE’s Financial Policy Committee
