Tuesday, June 10, 2014

Private banks are at odds with the law and ethics

There is no let up in the fines being imposed on banks. Banks are now waiting to see whether the reported $10 bn fine on BNP for violating US trade sanctions will materialise. We have the Libor rigging scandal earlier, the fine on Standard Chartered for busting Iran sanctions, the fine on HSBC on money-laundering charges in its Mexican operation.... one wonders when it will all end.

The problem in banking is that the combination of incentives linked to return on equity and persistent high leverage almost makes it inevitable that bank executives will look out for the sharp opportunity and the risky gamble. A modest increase in leverage does not solve the problem. Nor, as an article in the FT argues, will refining executive incentives and slapping fines on banks. The problems are fundamental and they require radical solutions:
As long as incentives are at odds with ethical requirements, common decency will be a minority pursuit. Scandals are inevitable. And as the gap between bankers’ pay and that of executives outside the financial system grows ever wider, business leaders lose moral authority, and the case for enlightened capitalism is devalued. There are honest people in banking. But it has become a less comfortable place for those with a strong moral conscience. 
What are the answers? The article suggests two. One is two go after bankers and prosecute them instead of merely slapping fines on bankers (which means you penalise shareholders rather than executives). The other is to treat banking as a utility, which would mean stringent regulation on what products they can offer, what returns they can make, what they can their executives etc.

The point is that private banks, as they are run today, pose major risks to society. Neither today's level of regulation nor the level of corporate governance diminishes this fact. It is astonishing that the P J Nayak committee on bank governance does not recognise this and argues for a diminished government presence in public sector banks and an aping of the ways of private sector banks, with boards being the key to good governance. It hasn't worked in the west and it won't work here.

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