By Roy C. Smith
The NY Fed said recently
it would hold a “workshop on bank ethics and culture” in the fall. It is
stepping up pressure on banks to exercise better leadership to prevent abusive
conduct that still seems prevalent in some institutions long after the lessons
of 2008 were absorbed. How it should do so is still in doubt.
Alleged rigging of LIBOR and foreign exchange markets, efforts
to aid clients in evading US taxes, and conflicts of interest and inadequate disclosure
related to dark pools operated by banks have been at the core of recent events
that have upset regulators.
Most of these allegations have involved foreign banks operating
in the US, but recent settlements of federal charges related to the sale of
mortgage-backed securities by JP Morgan and Citigroup (and prospectively Bank
of America) have kept US banks in the arena.
The Fed is suggesting that part of its annual stress test
evaluations of big banks will include queries into their ethical and cultural
fitness. If the threat of additional
multi-billion dollar lawsuits hasn’t been enough to get the attention of bank
CEOs, then possibly failing a stress test should be. The combined power of the
Justice Department and the Federal Reserve to punish discretionary findings of
a qualitative nature is certainly an important game changer for the US banking
industry. But is a new reality.
The banks might argue that they have been unfairly required
to shoulder most of the blame and financial responsibility for the economic
effects of the financial crisis. Much (though not all) of what they did was to
seek innovative but untested approaches to creating new products or client accommodations
for which there was considerable demand by knowledgeable financial institutions.
The banking industry is global and very competitive, and
individual banks must be innovative and accommodative to survive. They are also
corporate entities seeking to maximize profits in accordance with the law and ethical
norms. In times of market ebullience and technical changes such as CDOs and
high frequency trading, what the law and ethical norms may be can be quite unclear.
The Fed probably takes the view that much of what actually
happened was the result of the banks loosing control over the actions of their
employees who were aggressively taking as much advantage of the bubble as they
could to boost the banks’ profits and their own compensation. The ethical and
cultural tone of a bank needs to be set at the top, the Fed has been telling
executives, according to The Financial
Times, which all of the bank CEOs, of course, say they do.
What the ethical and cultural workshops will accomplish is
unclear. Such events have a history of being of little value, but, with some
effort by the Fed, the forthcoming ones could be quite useful.
The Fed could begin by defining the standards it wants banks
to meet. These should begin with the requirement that all banks strive to
achieve a culture that values high ethical conduct and insists on treating all
customers and clients fairly. The effort to do this is auditable to a
reasonable degree.
The Fed could say that it will provide a “safe harbor” for banks
(i.e., it will hold them harmless) if they can demonstrate that they have
adopted and enforce policies that make unit heads and mid level management
responsible for the integrity of products and marketing and sales procedures.
Those that involve potentially injurious conflicts of interest, or rely on
loopholes or technicalities to make it to market, need to be nipped in the bud.
Violators must be stopped at the point of origination, and dealt with
appropriately. Compensation policies also must be modified to allow generous bonuses
for problem averting activities, but, as with all bonuses, with meaningful clawback
provisions.
The safe harbor idea could be adopted by the ECB as well. It
has a similar need to upgrade ethical standards.
Making mid level managers responsible for playing defense
and well as offense may be a change that will require additional training over
time, but will produce better senior managers. There are thousands of these
people in every large bank, so a lot of management development work will be
necessary to reprogram them. Today banks
are hiring thousands of new compliance officials to manage the new regulations they
must accept, but these people are not the core future management of the bank,
the mid level people are. Hiring more compliance people should not be in lieu
of empowering mid level operating people.
The mid level guys are also the ones the banks depend on the
to make adjustments to products and services so as to adapt to the new regulatory
and market environment and to position their banks for the future. Perhaps they need a way to discuss new
product ideas confidentially with the Fed, either just before or after a new
approach is introduced. If the Fed
challenges the new idea, the bank should be allowed to withdraw it with
impunity.
For banks to be active and competitive they need also to be
healthy and economically viable. Investing in greater defensive empowerment of
the mid level could be economically very advantageous if it means banks can
avoid the massive legal costs of the past few years in the future, and if the
effort enables the banks to regain the reputational value that has been lost.
The largest capital market banks have been struggling for
years to regain economic viability and to restore their reputations. They could
benefit from some helpful understanding from the Fed, which, particularly in
view of its enhanced discretionary powers, should advocate roll-back of
restrictive regulations put on in the heat and darkness of Dodd Frank but not
really necessary to maintaining banks’ fitness and properness in the future.
All this is good stuff to discuss at a workshop, but finding
common ground for a workable safe harbor is the real objective.
From Financial News, 11
August, 2014
