Bank of England Governor Mark Carney makes a major speech at the Mansion House on 10 June 2015, with Chancellor George Osborne, and Lord Mayor Alan Yarrow. Governor Carney details the reforms that the Fair and Effective Markets Review will bring to ensure real markets and financial services that serve society, free of implicit public subsidy. In the speech, he details reforms under way to market-structures, standards, systems, incentives, training, etc, and outlines the work of the Markets Standards Board. The UK’s global reputation will, he says, be enhanced by the strong reforms under way, which will include individuals taking clear personal accountability for wrongdoing. He also details earlier failings of the Bank of England – as well as its successes.
“The age of irresponsibility is over” declared the governor of the Bank of England at the annual Mansion House dinner to the great and the good of the financial world. Along with the chancellor of the exchequer, George Osborne, Mark Carney unveiled a host of new sanctions and procedures designed to clean up financial markets.
Delivering the Fair and Effective Markets Review, an annual assessment of the way financial markets operate, they mentioned 11 recommendations ranging from new regulations against manipulating markets to tightening up hiring and training policy in the financial services industry. But the most eye-catching feature of the review was the demand for enhanced criminal prosecutions of “individuals who fraudulently manipulate markets”.
In Osborne’s words, people “who commit financial crime should be treated like the criminals they are”. The review therefore recommended that criminal sanctions for market abuse should be extended to traders in foreign exchange markets and that the maximum sentences for wrongdoing should be lengthened from seven to ten years.
Osborne and Carney were also critical of the Bank of England for failing to identify risks and abuses in the banking system in the run up to the financial crisis. But there are actually far more parallels between Carney and his predecessor, Mervyn King, than you might assume on the evidence of the Mansion House speech.
King, who experienced the banking crises (bail-outs and scandals) in the last few years of his governorship, was also critical of the failures of the largest banks. Carney has followed in his stead, voicing his criticisms of the industry, and has enjoyed new powers as a result of the Financial Services Act, passed in 2012. Strong criticisms have therefore been accompanied by new regulatory bodies such as the Financial Policy Committee and Prudential Regulatory Authority (replacing the old Financial Services Authority).
But the real message behind the Mansion House speeches is that the state’s approach to policing the banking system is indeed toughening – precisely because change has been so slow in forthcoming. Amid the creation of new, formal regulatory bodies (FPC, PRA, FCA), a host of other relatively informal, or advisory bodies have emerged too.
These include the Parliamentary Committee on Banking Standards and the Banking Standards Board. Another one was recommended in this latest review – the Market Standards Board. What all these bodies have in common is that they are trying to remedy irresponsible behaviour on the part of individuals working in financial services, and to improve the “culture” of banking.
Improving banking culture has two faces. It is partly a PR exercise aimed at improving consumer confidence in the banks. But it is also about addressing a more substantive threat posed by bad behaviour.
That change in culture has been slow. The recent forex scandal, for example, revealed that corrupt behaviour in these markets was still occurring in the UK up until 2014, long after the Libor, IRSA and PPI revelations.
The market police state
Many in the room at the Mansion House were expecting the big announcement to focus on concessions on the bank levy. The expectation – with half an eye on HSBC’s announcements (read: veiled threats) earlier in the week – was that the chancellor might cede some ground to the largest banks. Instead though, the ominous silence on the bank levy and the tough-talking approach reinforce an important message: that the state is no longer willing or able to turn a blind eye to irresponsible banking.
What is most noteworthy in the latest review is that it shows the Conservative government – known for its strong stance on welfare cuts and typically labelled a business-friendly party – is also taking a tough stance on the UK’s biggest industry, financial services. But this is not as surprising as it might appear. The same principles that underpin the Tories’ position on the welfare state also underpin their take on individuals who commit fraud and cheat in the financial services industry.
The Conservatives are fulfilling a role assigned to them by classical, liberal thinkers such as Adam Smith – that of a market police ensuring the “better” functioning of the market mechanism itself and maintaining the legitimacy of commercial society. This is because, in the mind of the Conservative government, it is not simply “free-riding” benefit claimants which threaten the market mechanism, but the collusive behaviour of individual bankers as well.
Ultimately, the Fair and Effective Markets Review is more than just another piece of clever political rhetoric. It is being backed up by genuine changes in the regulatory approach to anti-competitive behaviour in the financial services industry.
The hope is that, gradually, the culture of banking will indeed change and legitimacy and credibility can be restored to the banking system. But, as some commentators have also noted with some concern, the UK’s unhealthy addiction to cheap consumer credit, high levels of mortgage borrowing, and consumption-led recoveries, means that Britain’s financial worries run far deeper than just the behaviour of a few “bad apples” in the banking industry.
Author – Huw Macartney – Lecturer in Political Economy at University of Birmingham
At conferences in Sydney last week, the heads of ASIC (Greg Medcraft) and APRA (Wayne Byres) agreed on a few things: banking culture is rotten; culture is “hard” to deal with; and regulators are basically at a loss on what to do about it.
As reported in The Conversation, Medcraft said:
“When culture is rotten it often is ordinary Australians who lose their money. And that is my point – markets might recover but often people do not. So that is why we need to clean up culture because people suffer. And people are sick of it. They want to have trust and confidence in the institutions they are dealing with.”
Medcraft wants to be able to criminally charge banks and their directors when company culture has allowed for staff misconduct.
Medcraft’s outrage disguises the fact that Australia’s regulators may have had something to do with fostering a “rotten” banking culture. For example, when the Four Pillars were fined some A$1.7 billion and censured by the New Zealand High Court for Tax Avoidance neither regulator censured the boards or senior management of four banks, or even commented at the time on the cultural messages such behaviour would inevitably reinforce.
To give ASIC credit, in another speech last week Commissioner Greg Tanzer outlined a very long laundry list of things ASIC is now going to look at relating to culture, including: reward structures; whistleblowing policies; conflicts of interest; complaints handling; and corporate governance.
The regulators might wish to look the latest research showing the avoidance culture behind the risk taking by Australian bankers.
Or the experience overseas showing the difficulties of actually changing banking culture.
But the problem is wider than individual banks and includes the culture of the banking and regulatory system itself.
A system beset by groupthink
While Australian regulators bemoan the industry’s culture problem, the Irish parliament is holding yet another inquiry into the tragedy that beset the Irish banking system before the global financial crisis. Irish finance leaders have fronted the inquiry, singing from the same songbook. From bankers, regulators, auditors, the media, to academics, commentators and managers of construction companies, (almost) all were repeating the same thing – ‘No one – but no one – saw it coming’.
There were a few exceptions who had been off-key before the crisis, including Professor Morgan Kelly and a brave regulator, Con Horan, who had warned of the impending calamity but was told not to rock the boat. Aside from those notable exceptions, everyone else appeared to be on same page.
In behavioural economics, such “concurrence” across a group is called groupthink. Everyone in Ireland, or at least those in charge of the financial system, believed the economy would keep growing forever. And why not, as Ireland was in the midst of a 25-year boom – sound familiar?
Groupthink (or more properly in this case “systemsthink” because the whole system was deluded) is unhealthy because, not only do people start to think alike, it is only a short step to believing people who are singing a different tune should be excluded and thrown out of the chorus. Dissent can be destructive, but the role of the Devil’s Advocate is well-understood to be valuable, drawing out important questions people would rather not answer.
But it’s not only in Ireland that people are afraid of rocking the boat. In Senate hearings this week into high credit card interest charges, RBA Assistant Governor Malcolm Edey admitted the Reserve and Treasury were aware of the problem, but said it was not up to them to question Australia’s banks on card rates. He recommended ASIC or APRA be the people to ask, if one was really worried. Since the RBA, APRA, ASIC and the Treasury are the four members of the Council of Financial Regulators (CFR), one would have thought that one of their regular meetings would have been an ideal opportunity to bring this issue up – but no one did.
It is the primary role of Australia’s banking regulators to promote systemic stability. But what if the whole system, including banking regulation, is deluded (as happened in Ireland)?
So how could a Devil’s Advocate be introduced into the regulatory process? The recent Murray Inquiry into the Financial System made one recommendation that could help. The inquiry recommended the establishment of a new Financial Regulator Assessment Board (FRAB), which would be asked to “assess how regulators have used the powers and discretions available to them”.
The Murray inquiry envisaged that this new board would consist of knowledgeable experts, crucially not tied to regulators, with a diverse membership that would “act as a safeguard against the FRAB being unduly influenced by the views of one particular group or industry sector”. The Inquiry also recommended that FRAB’s assessments of regulators should be made public. The creation of the FRAB is awaiting the government’s response to the Murray proposals.
Experts, such as Dr Andy Schmulow, suggest the FRAB proposal may however be dead on arrival, due to push-back from regulators. That is a pity, as regulators should welcome the creation of such an independent body, even though they know it may cause them some uncomfortable moments along the way. Constructive questioning of perceived wisdom will enhance rather than reduce systemic stability, which is after all the goal of banking regulation.
By Pat McConnell, Honorary Fellow, Macquarie University Applied Finance Centre at Macquarie University. Article published in The Conversation