For too long bankers have been able to benefit from a one-sided toss of the coin – heads they win, tails the taxpayer picks up the tab. Individual bankers kept their bonuses while taxpayers faced multibillion-pound bailouts.
The response to the banking failure of 2008 continues to sound tough but risks missing the mark in changing the culture for individuals within financial institutions.
Talk of criminal sanctions, as set out in the Parliamentary Commission on Banking Standards, and on Monday backed by chancellor George Osborne in his response, has grabbed headlines. Many people want to see golden handcuffs replaced by the prison variety.
Yet the government’s proposal to introduce a criminal offence for reckless misconduct for senior bankers is unlikely to amount to more than rhetoric. If regulators failed to gather sufficient evidence for the lower standard of civil penalties to impose fines, why do we automatically assume they will be able to gather evidence to meet a higher criminal standard of proof?
Parliament has a long history of passing new laws that sound tough but are then rarely used. Criminal penalties for bankers will capture the foolish – the trader boasting about the next binge on bottles of Bollinger – but few senior executives of top banks are likely to be so reckless in their emails. The top bosses will instead hide behind denials, saying they were unaware of bad practice.
It is now welcome that the government has accepted the principle of a reversal of the burden of proof, so that the onus falls on the bank executive to show that they took reasonable steps to prevent a banking failure, rather than on the regulator to evidence wilful misconduct or act of omission, which by their very nature are difficult to prove. This change is a positive step but it risks being undermined by the new condition introduced by the commission that a successful prosecution must first be concluded against a company.
My proposed amendment to the banking reform bill removes that constraint. It is also naive to think that a chief executive will quickly settle the regulatory action against their company, thereby opening the door to enforcement action against them personally. Such a constraint can only add further delay and cost.
Unless an executive is foolish, they are unlikely to leave an evidence trail incriminating themselves. They will instead rely on oral briefings where information is seen to carry risks. As a result regulators face huge costs and delays in being forced to sift through endless emails, often in a vain search for what was a verbal discussion.
By reversing the burden of proof bank bosses will have to show they personally took reasonable steps to understand what was happening on their watch. If executives justify large bonuses when things go well because of their hands-on leadership, the same executives can hardly claim ignorance when things go badly wrong. At present regulatory failure results in a fine against the company – and the fines are tiny when compared with the company’s overall costs.
While it is tempting to suggest that the fine should be increased significantly, the risk is that this simply hits the public twice, through the cost of any future bailout and the cost of the fine to shareholders including pension funds.
Some modest steps have been made to claw back individual bonuses, but these are limited to a three-year period so problems will often emerge after part or all of the bonus has been paid.
Those in any doubt about the failure of individual fines against bankers need only look at the two biggest individual fines against bankers linked to the 2008 crisis. In both cases their fines were less than the same executives received in their bonus the previous year. It is not surprising that those employed in financial services to assess risk judge the risk of firstly getting caught and then paying a fine of less than one year’s previous bonus to be a risk worth taking.
One of the Barclays executives – Rich Ricci – recently named one of his many racehorses “Fat Cat in the Hat”. Clearly naming and shaming executives who have failed is ineffective, as many have no shame. Nor does fining their companies hurt them, as most leave when trouble arises and it is the shareholder who pays.
In the past the partners of merchant banks had skin in the game. They knew if the bank went bust they would lose large sums as individuals. We cannot turn the clock back to the days of such partnerships. But we can ensure that those at the top of institutions are personally encouraged to ensure risk is well managed.
Reversing the burden of proof will not damage executives who can demonstrate they have acted reasonably. For those who cannot, it is time to hit them where it hurts most – in the pocket.
This article first appeared in the Financial Times here (£).