Moral hazard: the ghost of bail-outs past

Aamir Khan is general counsel at Clutch Group

The bailout of Espirito Santo Bank brings back unwelcome memories of the events of the last financial crisis and raises the spectre of moral hazard returning to the financial services industry both in the UK and abroad.  But how far have we really come since those dark days of 2008 and the collapse of Lehman Brothers and how far do we still have to go? A quick look at recent events gives us a good indication, writes Aamir Khan.

Firstly, the Competition and Markets Authority announced a new investigation into the retail banking industry, which may lead to further break-ups of the major players and the possible end of “free banking” with the objective of increasing competition. The concerns around a lack of competition remain, notwithstanding the fact that there have been several recent entrants in the UK banking sector as well as the spin off of TSB Bank from Lloyds Banking Group.  Then the Serious Fraud Office announced that it will begin criminal investigations and prosecutions into the fixing of foreign exchange rates. At the same time, the Financial Conduct Authority announced that the time limit to bring claims against individuals would increase from three to six years, bringing those timelines into line with civil claims.

Then the payday lender Wonga.com was reprimanded by the FCA for sending misleading letters to customers from two “fake” law firms that did not exist and ordered to pay its customers £2.6 million in compensation to some 45,000 customers. However, the attention soon shifted to the retail banks and their own practices of using their in-house litigation teams to send out law firm branded letters. It has been argued by commentators in the media and politicians alike that this basically amounts to the same sharp practice adopted by Wonga.com. A closer look actually suggested that the use of a law firm brand name on a letter sent out by an employed lawyer of a company is a practice accepted by the Solicitors Regulation Authority as legitimate and one the SRA has known about for many years and approved.

Most recently, Bank of America reached a settlement with the Department of Justice, various federal agencies and six states which amounted to a total of $16.65 billion in relation to various practices around packaging and selling residential mortgage backed securities, which were at the heart of the sub-prime lending crash of 2008. Most of the settlement figure will go towards helping the real victims of the sharp practices, those who borrowed to buy residential homes, although around $5 billion will still be paid in fines.  One could count Bank of America unlucky. This follows other eye-watering settlements of $8 billion with JPM and $7 billion with Citigroup in relation to the same issues around sub-prime lending.

These developments and headline-grabbing settlements might suggest that the financial services industry has still got some way to go before it can truly restore its reputation. However, many of the issues being reported today and the settlements that are being announced are the consequences of the decisions and actions of the past, whether it’s the fixing of benchmarks by investment banks or the mis-selling of everyday retail products by the retail banks.

Indeed, one of the enduring consequences of the financial crisis has been the additional scrutiny of the regulators themselves as well as those who are regulated. This may help explain the record fines and settlements being brokered by overseas regulators (read US regulators) on “foreign” banks such as BNP Paribus and HSBC.

Having been criticized at the outset of the financial crisis for being asleep on the job, the regulators now appear to be on overdrive, with the actions of US regulators in particular generating concerns of “financial imperialism”.

However, a cursory look at the speeches of various chief executives and a sneak peek in the reception areas of the “big four” UK banks reveals a well-intentioned desire to change their companies’ cultures and to renew their customer-centric focus. And no one can deny that the banks have taken some positive steps – they’ve begun to strengthen their capital positions, hive off toxic assets into “bad banks”, take a hard position on misconduct by individuals, and to invest heavily in risk and compliance professionals. However, there is no easy way to quickly and uniformly impose a new approach and culture on a large organization, particularly one that is likely to mean less profits in order to focus on compliant selling and putting the customers first. In many ways there remains a long way to go before banks can achieve the fundamental shift in culture that is needed to win back the confidence of their customers, the public and the regulators.

Unfortunately, every time another settlement is announced, another investigation is initiated or another mis-selling “scandal” comes to light, the ghost of moral hazard resurfaces and the good work done by the banks since the crisis is quickly forgotten.  Could it be that the way we view banks and our relationships to them have permanently changed?