Banking Standards Consultation Paper 2014

Banking Standards - Consultation Paper February 2014 Banking Standards Review Submission by Transparency International UK (TI-UK) March 2014

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Submission by Transparency International UK (TI-UK) Summary 1. Introduction The culture of banking needs significant change. The evidence for this is the litany of scandals that have dogged the sector over the last 30 years, culminating in the financial crisis of 2008 and its aftermath. That crisis is only the most vivid example of recurring episodes of unethical behaviour in the sector, which includes well-known episodes of bribery, fraud, misselling of financial products, manipulation of financial markets and insider trading.

It is no exaggeration to state that these serial failures of integrity have at times tipped over into outright corruption. Moreover, in recent years evidence has emerged of the complicity of banks in the flow of illicit funds, including the proceeds of corruption, around the world. Despite extensive antimoney laundering and counter-terrorist financing regulation, banks have routinely proved inadequate in vetting the source of funds deposited with them. This, too, reflects organisational culture and values.

Changing that culture will require concrete and measurable changes to the way that banks conduct their business. It will require a lasting commitment from within the banking sector, from senior management. It will also require sustained pressure on senior management from multiple external sources, including regulators, investors, customers and civil society, all of whom are needed to promote this significant cultural shift.

Since the 2008 crisis, there has been sustained interest by numerous stakeholders in addressing how banks exercise a wider responsibility towards depositors, tax-payers and society more generally.

However, the problem is deeply rooted, and there are signs that these behaviours will persist once the attention of external parties such as regulators and the public wanes. If real and permanent changes are to take place in banking, it is necessary to capitalise on the public, political and economic concern about practices in the industry.

Thus far, attempts by the banking sector to revive its reputation appear to have failed – a survey of UK consumers four years after the Lehman Brothers collapsed showed that seven out of ten citizens do not think banks have learned lessons from the crisis, an increase of 10% from the same survey a 1 year earlier. This critical public view might also be explained by the lack of transparency practiced in the sector – Transparency International’s research on the public reporting of basic information related to integrity issues by some of the biggest global banks reveals that banks perform well below their peers in other sectors.

This shortfall in integrity and transparency should be a concern to wider society. On the one hand there are social and economic costs of the numerous financial crashes that they exacerbate. On the other hand, societies and economies are damaged by corruption, terrorism and organised crime, which is facilitated by the role of the financial sector as a conduit for illicit financial flows. The scale of these flows is enormous: there are reasonable estimates that the volume of illicit funds flowing out of sub-Saharan Africa each year is greater than the volume of aid money that flows in. Under the current global anti-money laundering system, the front-line defence against this is the integrity of the banks.

Clearly, such large-scale flows cannot occur without the active participation of the financial industry and ancillary services in law and accounting. The millions of euros deposited in European banks by political leaders deposed in the Arab Spring – amounts that cannot be explained by the publicly declared assets of these leaders – demonstrate the ineffectiveness of the current anti-money laundering regimes in preventing corrupt funds from being recycled and point to persistent integrity issues in the banking sector.

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Full references for data and citations used in this paper are available from Transparency International.

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One of the explanations for this integrity gap is that the short-term financial rewards for bank employees far outweigh the personal and institutional downside. Public anger rarely translates into direct consumer action, partly due to the comparative difficulty of switching financial service providers and partly due to the perception that financial institutions are “all the same”. Despite the crisis and its impact, investor focus remains predominantly on short-term profitability.

While there has been renewed shareholder activism with regard to governance and remuneration, there is still insufficient engagement on broader transparency, integrity and accountability issues. In short, there is little motive for senior management in the banking sector to undertake serious and sustained reform. In an economic and regulatory environment where financial institutions are under pressure to raise capital, increase lending to business and to restructure as old business models become unviable, there is even less prospect of change coming from within the sector once the media spotlight moves on.

Overall, Transparency International UK believes that among the broad objectives underlying the 2 Banking Standards Review (BSR) should be:  to improve integrity and behaviour within the banking sector and reduce both systemic corruption and individual incidents of corruption  to reduce the flow of the proceeds of corruption through the banking sector.

In some senses, we are surprised by what the BSR consultation paper misses out. This will become apparent in the answers to the detailed question, but in summary they are:  The role of civil society. There is an active network of civil society organisations with an interest in banks and ethics, notably corruption and money laundering. They do not appear to have been part of the initial consultation or considered within the paper. They include, apart from Transparency International, the Bond Anti-Corruption Group, Global Witness, Tax Justice Network, and some of the global development NGOs. These organisations are typically fairly critical of the banking system. If they are dis-engaged from the BSR process, they are less likely to be supportive of it. We believe that civil organisations that are critical of the banks, and which focus on issues such as money laundering and illicit financial flows, must be a part of the BSR process.  Retail banking focus. The consultation paper seems to focus substantially on retail banking, whereas the lapses in integrity have been as large, if not larger, in investment banking. The retail banking focus is implicitly on the UK, whereas lapses of integrity have been notable in divisions such as High Net Worth customers, which typically involve a global client base.  Global banking standards. The position of London as a global financial centre means that action arising from the BSR will de facto set a global standard. All significant global banks have a presence in London. This is a strength that should be recognised and built on. The BSR should not attempt a parochial fix for the UK. Its aspirations should be to set a new global standard that will be co-designed and adopted by global banks that have a presence in London.  Corruption and money laundering. As outlined above, these represent major ethical failures by the banks, yet do not appear to be mentioned at all in the consultation paper. They are not solely symptoms of the underlying problem of lack of integrity. They are issues of great significance to society and vast in scale – as large as the misselling scandals that are addressed in the consultation paper.

This consultation response is submitted by Transparency International UK, drawing on the Financial Integrity Initiative run by Transparency International’s global secretariat in Berlin.

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For convenience, we refer in this response to the BSR as a proxy for any successor body or organization that is created.

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Consultation questions Question 1 Do you agree with the objective to establish a new independent organisation with the aim of defining and raising standards of conduct and competence in banking?

Response Yes. We believe that its independence is critical, especially given the plan to fund it through bank contributions and that it has been initiated by the banks. If the independence is achieved, the new body will play an important role in global banking.

Question 2 Do you agree that there is a case for a collective approach calling for the participation of all banks doing business in the UK? Response Yes. This should include not just domestic banks but non-UK domiciled banks, similar to the Wolfsberg Group. A body that only involved UK domestic banks will be unable to address some of the most pressing issues.

Question 3 Do you agree with the proposed role of the new organisation to set standards of behaviour and competence for banks and building societies, and to define metrics against which they could benchmark?

Response Yes. Transparency International has considerable experience of benchmarking company 3 performance, and we believe that it is an effective means of promoting change. There are many methodologies and techniques for such benchmarks, and it would be important to plan an approach that genuinely challenges banks and promotes performance improvement but also makes banks themselves feel it is a valuable and fair exercise.

Question 4 Do you agree with the proposed scope of the new organisation to include all British banks and building societies, and foreign banks doing business in the UK? Response Yes, as per our response to question 2.

Question 7 In the section titled ‘Ethics’, a case is made for a more pro-active approach to managing ethical issues. Do you agree with this, and if so how should it be done?

Response Yes. This is fundamental to the entire project. In terms of how it should be done, an extensive body of experience has developed in relation to the Bribery Act, from which lessons could be drawn.

Question 8 Do you agree with the proposal to build on best practice as set out in the regulators’ guiding principles?

Response Yes. We have reservations about the development of a compliance industry which can promote a tick-box approach and create a ghetto of compliance professionals, rather than an adherence to

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Refer, for example to TI’s indices of transparency in corporate reporting and defence companies’ anti-corruption procedures: http://companies.defenceindex.org/; http://www.transparency.org/whatwedo/pub/transparency_in_corporate_reporting_assessing_the_worlds_largest _companies; note also that Transparency International is also currently developing a Financial Integrity benchmark

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underlying ethical principles by all employees. It is important to avoid a proliferation of codes or guidance, and therefore building on existing good practice guidance is a sensible approach.

Question 9 What would be the best way of assessing the implementation of a bank’s code of conduct?

Response There is a body of existing good practice that should be consulted. It needs to combine a quantitative approach, such as the benchmarking exercise, and a qualitative approach, which looks at implementation in reality. However, the creation of a new body with code, standards and benchmark should specifically aim not to create a new sub-industry of compliance assessors and monitors. The BSR should learn the lessons from implementation of the Bribery Act and Anti-Money Laundering regulations.

Questions 13-16  Do you think a benchmarking exercise, to help banks identify areas for improvement, would be of value?  Are the groups of metrics outlined in the section titled ‘Benchmarking’ the correct ones? Would you propose others?  Is self-reporting appropriate? Might other methods deliver better results?

Response We believe that benchmarking can play an important role in driving performance. Results need to be made public.

The metrics outlined in the consultation paper are disappointingly narrow. They would not capture the essence of a bank’s integrity or ethical behaviour. The creation of a credible benchmark is potentially such a crucial part of establishing the credibility of the BSR that a separate exercise should be undertaken that would actively solicit and review a full range of stakeholders’ views about what subjects should be covered and what would be suitable metrics.

Self-reporting is one of a range of techniques that can be used for such benchmarking. It has pros and cons, and can be supplemented by other approaches. Benchmark methodologies is a subject in its own right and we recommend that before committing itself to a specific approach the BSR should thoroughly review and assess all the available options.

Question 17 Are there non-bureaucratic alternatives to the approach outlined in the section titled ‘discipline’ that might work better? Is there a role for kite-marking?

Response We believe that remuneration and incentive structures are a vital part of improving ethical behaviour.

This needs to be a prime part of the debate generated by the BSR and any benchmark that is created. If BSR does not seek to tackle this issue, the risk is that it will fail to gain credibility while at the same time building a body of critics who will easily be able to undermine it.

Question 19 Should the new organisation aspire to a role as a thought leader in banking, sharing best practice and helping to propose solutions to challenges that arise in the future?

Response Yes. This is a fast-moving global industry with London as its epicentre. The BSR should be equipped to respond to changing circumstances.

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Annex I Transparency International UK (www.transparency.org.uk), the UK national chapter of TI, fights corruption by promoting change in values and attitudes at home and abroad, through programmes that draw on the UK’s unique position as a world political and business centre with close links to developing countries.

Transparency International UK:  Raises awareness about corruption;  Advocates legal and regulatory reform at national and international levels;  Designs practical tools for institutions, individuals and companies wishing to combat corruption; and  Acts as a leading centre of anti-corruption expertise in the UK. TI-UK’s vision is for a world in which corruption is greatly reduced and the UK has zero tolerance for corruption both at home and abroad.

Transparency International is developing a Financial Integrity Initiative with an accompanying benchmark, through the TI global secretariat in Berlin. TI-UK has full access to TI’s global expertise on financial integrity, research and benchmark tool development, and global outreach and advocacy networks, and is willing to coordinate this with BSR to help promote the best outcomes for financial integrity.

Contact: Robert Barrington Executive Director Transparency International UK E: robert.barrington@transparency.org.uk T: + 44 (0)20 7922 7906

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