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Financial services’ credibility hits rock bottom

C.Gopinath
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C.Gopinath
C.Gopinath

The popular perception of a used-car sales professional in the US is that of a fast-talking sleazy individual who is not very trustworthy. He is seen as one who will say and do anything to sell you an unreliable car. The financial services industry is now a strong contender for that position at the bottom of the credibility list.

We have had a string of scandals and frauds in banking, in particular, and in financial services, in general, that would make heads of drug cartels and gun runners blush. The industry suffers from a precipitous drop in professional ethics, culpability and gross incompetence. Moreover, recent incidents also tell us that our belief that more regulation would help is also misplaced.

Moody’s and the other rating agencies, which themselves have seen their image tarnished during the 2008 financial meltdown, have downgraded the major US banks as a serious reflection on their capital adequacy and general financial stability.

libor et al

Take the recent Libor (London inter-bank offered rate) scandal. Over the years, it grew to be a highly trusted base rate on which consumer and business loans and trading contracts around the world are now based. Barclays PLC, a British bank, reached a $450-million (about Rs 2,430-crore) settlement with the UK and the US regulators; but 11 other banks are believed to be involved in this scandal.

A former executive of Barclays said he was not only following the orders of his boss but also those of regulators when he understated borrowing costs. Evidence is also emerging that the British Bankers’ Association themselves wanted this rate to be more carefully regulated, but the Bank of England did not. And we don’t know for how long and how extensively this manipulation has been going on.

HSBC Holdings PLC, a giant global bank, has recently admitted that its lax systems and supervision facilitated money laundering by terrorists, gun runners and drug lords. Regulators say they have warned the bank for years that its far-flung global operations have become a conduit for questionable money. But each time the bank received only mild sanctions in return for promises to do better in the future.

Peregrine Financial Group, a US stock-market brokerage firm, came into focus two weeks ago because of a suicide attempt by its boss. In a confession letter addressed to his son, who also works for the firm, the CEO, Russel Wassendorf, admitted to misappropriating about $215 million (about Rs 869 crore) of client funds by falsifying bank statements over a period of 20 years and using the money for buying an office building, and such. During all this time, several audits of his accounts had taken place with no suspicions aroused.

JPMorgan Chase, the largest US bank, was hit by several billion dollars in losses incurred due to trading blunders at its UK investment office -- activities that border on criminal negligence.

Its CEO, Mr Jamie Dimon, who insisted till recently that the problems were not severe, claims that he was regularly told everything was fine and he believed the reports. Mr Dimon was for long lauded as the sharpest needle in the banking haystack and an example of why we are justified in paying globs of money for the talent it takes to manage complex enterprises. Ha! He was also the mouthpiece of the industry against increased regulation.

Sorry state

Every era has had its share of dirty bankers, but they were few and far between, and when they dipped their fingers in the till, they were caught and sent to prison. What is different now is the extensive nature of these occurrences and the almost complete lack of accountability. Each time they are caught, armies of lawyers descend to fight their cases or negotiate settlements, and the bank pays, which means all the investors and depositors pay.

The power of the bankers over the governments, especially in the US, arises because of the revolving door between the banks and the treasury departments. The politicians are beholden to them for their power to donate to political campaigns. The financial services industry has managed to build a myth that if they are disturbed, then the world economy would go under. With the industry failing in self-regulation and the regulators also falling on the job, it is a sorry state of an industry that claimed the high ground as an engine of business growth and economic development.

CEOs have quit; risk officers have been fired; apologies have been offered; settlements have been arrived at. Is anything likely to change? It is too much to expect the morality discount to suddenly reverse and expect them all to become good. The only hope for better behaviour from the financial services industry is if we make the individuals pay. We need to hit at the reward systems of the decision-makers.

An insider told me that the industry would not change as long as there were opportunities to make lots of money personally with little risk attached to failure. So, hit the CEO where it hurts the most — compensation. How about this simple rule? The government should require, as part of the settlement, that the CEO of any firm found guilty of malpractice or malfeasance would continue to head the firm for three years at a compensation that is 25 per cent of the previous three years’ average.

You can be sure that this prospect of low pay along with the shame of turning up daily at an office that he ruined would keep bank CEOs awake at night to ensure that their compliance is over and above what is required. The trickle-down effect in the bank or brokerage house would similarly be most enlightening.

(This article was published in the Business Line print edition dated July 30, 2012)
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