Investment banking: If you ain't cheating, you ain't trying

A V Rajwade says global banking has changed for the worse as reports of malpractices and regulatory fines have become routine

After the financial liberalisation under the Reagan-Thatcher ideology, global banking has witnessed “The Death of Gentlemanly Capitalism” and the birth of “The Greed Merchants”. (Incidentally, these are titles of two books by Phlip Augar, an old-time City professional.) This has led to an “obscene bonus culture”, as one former chairman of Barclays Bank remuneration committee once described it. It is debatable whether the culture has changed much even after the financial crisis of 2008, as reports of more malpractices and fines keep coming out. Last week alone, (i) Anshu Jain resigned as co-chief executive of Deutsche Bank, partly as a result of the bank being fined $2.5 bn a couple of months back for manipulating the LIBOR rate; (ii) HSBC agreed to pay a fine of $43 mn to the Swiss authorities to settle a money laundering investigation; and, (iii) Barclays was found to have been involved in manipulating the ISDAfix, the benchmark swap rate. Incidentally, “If you ain’t cheating, you ain’t trying” is an extract from one of the emails from one bank to another, which came out during the investigations in manipulation of global currency markets, culminating in a fine of $5.6 bn imposed on some of the largest investment banks last month.

 
In fact the deceptions start with the very name: investment banks. At one time, the business of investment/merchant banks was to raise long term funding for their clients in debt and equity markets. Today, much of their profits come from trading, a euphemism for what really is speculation in FICC (fixed income, currencies, commodities) markets, both cash and derivatives. The complex mortgage-backed securities, which led to the 2008 financial crisis, was part of the activities of such investment banks. The crisis led to the largest drop in global economic output since the 1930s depression: the International Labour Organization recently estimated that, but for the crisis, global employment today would be higher by 61 million!

 
Including the penalties imposed in November 2014, the aggregate fines levied by regulators for rigging the foreign exchange rates amount to $10 bn plus. The banks may also face claims from clients who lost money because of the manipulation of rates. Adding the earlier penalties for rigging the benchmark LIBOR rate, the total fines so far are in the neighbourhood of $20 bn. In recent testimony, a banker has said that while he worked at UBS and Citigroup, rigging LIBOR rates was an industry wide practice (Financial Times, June 2, 2015). Many banks have been fined for money laundering, tax evasion, misstating accounts, selling unsuitable products to unsophisticated clients etc.

 

This columnist, in his role as a risk management consultant, has come across hundreds of cases of unsuitable, high margin products sold to “hedge” currency exposures of unsophisticated clients in India. In fact, complex, structured products often have net margin of 5-6% of the notional – after hedging cost, compensation for counterparty credit risk etc. This means that on a $100 mn notional transaction, treasury profits go up by $5-6 mn – and the marketing teams bonus by a million or two! The temptations are obvious.
 
One interesting part is that few bankers who indulged in these malpractices, or their seniors, have been criminally prosecuted. As Senator Elizabeth Warren recently said in exasperation, “The message to every Wall Street banker is loud and clear. If you break the law, you are not going to jail.”

 
The other corollary is that if bankers get away with malpractices, they receive bonuses; if they happen to get caught, the shareholders pay the penalty – over the last five years, the penalties, legal costs and provisions for further costs and claims have totalled $300 bn! In the long run of course these will be recovered by the banks, with customers being charged higher fees – also for the cost of servicing the higher capital charges imposed by Basel. “Heads I win, tails you lose”!
 
Recently, a banker of Indian origin working for Goldman Sachs, killed himself, tired of 100-hour weeks, of the pressure to produce ever larger profits, etc. I wonder whether his decision would have been different had he read Lucy Kellaway’s piece in Financial Times (May 25), “I would rather shine shoes than be a banker!”