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Clear Thinking Case Study of the Month


  

The Story

Jun - Aug 2012

“Reputation of Banks and Financial Advisers shredded - yet again” 

After the PPI mis-selling scandal comes the Libor-fixing scandal, money-laundering scandal, and the Iran-sanctions busting scandal. The banks have been slated by the media virtually every day since Barclays was fined £290 million by US and UK regulators for prolonged manipulation of Libor, the interbank lending rate used to price £-trillions of mortgages and loans.

Many other banks are being investigated in what could be an all-embracing rate-rigging scandal. Other abuses, such as money-laundering and Iran-sanctions-busting have peppered the papers – and hammered banks’ share prices. We examine the effects on the industry’s reputation and belated efforts to change and control what is seen as a ‘greed’ high-risk culture.

Key points of the Story

Libor-fixing on a grand scale

Barclays set the banking industry reputation ball rolling downhill again when it agreed to £290 million fines set by financial regulators in the US and UK for manipulation of submissions used to set the Libor rate. Emails between traders emerged such as “Dude. I owe you big time! Come over one day after work and I’m opening a bottle of Bollinger”. Several other big banks are under similar investigation. Barclays’ share price fell about 16% when the news came out. Shortly after, CEO Bob Diamond was forced out.

 HSBC come clean on money laundering

 

The US Senate claimed that HSBC bank was a conduit for alleged drugs money in places like Mexico. The bank has admitted its ‘mistake’ and has taken a $700m charge against expected fines. Its head of compliance resigned. HSBC’s culture has been “pervasively polluted for a long time” said Senator Carl Levin who led the investigation.

Standard Chartered admits to Iran sanctions busting

‘Rogue’ New York regulator Benjamin Lawsky jumped the gun on other regulators by accusing hitherto-respectable Standard Chartered of hiding $250bn of transactions by Iran. He even threatened to cancel the bank’s New York trading licence. Standard Chartered’s shares plunged 20% on the news. The bank hit back citing ‘inaccuracies’ and would only admit to a small percentage of transactions made in error. However they quickly realised that their best reputational and operational solution was to come to an agreement and accepted a $340m fine.

Regulators start to take real control, at last

 

From January 1st Independent Financial Advisers and others selling financial products (eg in banks and building societies) will lose their lucrative sales commissions paid to them by providers (eg Insurance companies). Instead they will need to charge the customer for advice. This should end the years of dubious practice where this so-called independent, ‘free’ advice actually cost the customer up to 9% of their investment.

They will also force banks to prove that they are safe and make named executives accountable. The splitting of retail and investment arms is still to be addressed.

 

Analysis and Lessons

Facts Thinking ... Problem Solving Thinking Process ... Controls Thinking
... Risk Thinking
… Design Thinking ... Consequence Thinking ...
Change Thinking Process ... Business Thinking ... Customer Thinking

Libor rate fixing – when begun, when discovered?

This grand-scale Libor rate manipulation appears to have no defined starting date and may have begun years before the year 2006 that investigators have disclosed. Reports suggest that certain regulators discovered the scandal in 2008, yet it took some years for concerted action to be taken, resulting in Barclays being fined £290m. This is poor Facts Thinking by the regulators, and the situation is now worsened by the potential threat of criminal action against the only people who know the facts.

Regulators slow to solve the problem

Clearly the regulators had great difficulties working out how to solve this problem. Bob Diamond even gave the impression that Barclays had the tacit agreement of the Bank of England to continue the practice during the 2008 credit crisis, although this is denied by the BoE. But the question remains: why did the regulators dither for so long? We suspect the reason comes down to failing to clearly define the problem, in part due to the way Libor was designed, and assessing the significance of the consequences. These are two different, but connected, crucial stages in the Problem Solving Thinking Process.

Putting the onus on the risk-takers to prove safety

Finally the regulators have found the right approach to dealing with financial risk-takers – make them prove that their systems are safe and make them accountable for mistakes (Controls Thinking). And to make them think a little more about selling risky financial products they should also have their own personal remuneration systems more aligned to investors/shareholders’ interests (Risk Thinking).

Flawed design and control of Libor system

It has now being recognised that the Libor system has a key design flaw and that the system needs a redesign. This was poor Design Thinking by the regulators when the system was set up many years ago. The design flaw is that the system relies on the banks being truthful about the information they individually supplied to the body that collated this data and set the common rate of Libor. This suffers from the risk of human behaviour intervening with the process without adequate controls to detect malfunction. So it is also poor Controls Thinking.

The potential consequences of the Libor scandal

The significance of the rate rigging is unclear, eg it is not yet established what the effects were and who suffered financial or other negative consequences. But litigation has commenced, with some commentators suggesting claims of several $billions. Hence the sudden collapse in certain bank shares. However, guilt is going to be incredibly difficult to prove as so many banks were involved in the process and litigants would also have to prove actual premeditated wrongful manipulation that had a direct link to losses that would not have otherwise occurred. Needs clever Consequence Thinking.

Reputation effects and Change?

This is a very interesting question. The media are constantly claiming that the banks’ reputation has been shattered by the succession of scandals and ‘greedy’ bonus culture. However, the big banks are in an incredibly powerful position and the consequences of all these scandals and bad press may turn out to be minimal.

The banks are seen as necessary to economies and there is not much individual governments can do. Investment bankers can move anywhere in the world to continue their ‘cowboy’ ‘casino’ activities. We still await the details and impacts of new laws aimed at splitting the retail arms from the investment banking businesses and the increased capital requirements.

Shareholders seem divided about this whole issue and some even wanted to keep Bob Diamond as CEO of Barclays. And this is despite Barclays’ share price underperforming the FT-100 by 60% since the credit crisis began, and a reported £5bn in pay bonuses by the ‘casino wing’ last year and £119m being paid to Mr Diamond since he joined the board in 2005.

Do customers care enough to cause Change?

 

Currently in the UK there is simply not enough competition to worry the big banks, and it is not that easy to switch supplier. No matter how much customers groan about the banks they seem reluctant to switch allegiance. That situation is unlikely to change unless a sizable competitor emerges. As far as the  Change Thinking Process goes, we doubt if the big banks see a need to change yet. That’s the first step in the Process.

However, it is interesting that Tesco Bank, with 6.5 million customers, has joined the mortgage market with deals that ‘fall short of best buys’, and is accused of ‘failing to help first time buyers by demanding at least a 20% deposit’, according to one report. This is rational Business Thinking by Tesco and will probably succeed purely because of the customer loyalty it has built up over years - good Customer Thinking. So there is some hope for change, if Tesco and others can take market share. 

 


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