It seems that hardly a month goes by without one of the banks receiving a huge fine from a regulatory authority. In December the European Commission fined eight banks – including the ever present RBS - a total of 1.7bn euros (£1.4bn) for forming illegal cartels to rig interest rates. The Financial Conduct Authority (FCA) and its predecessor the Financial Services Authority (FSA) handed out almost £500m in penalties last year. In 2007 before the financial crisis really took hold it was just £5m. The FCA penalised Rabobank and RBS to the tune of £193m for attempting to rig LIBOR while in 2012 UBS and Barclays were together hit for £220m for the same offence.  The regulator also fined JP Morgan £138m for the so-called London Whale scandal for failing to control a rogue trader who clocked up huge losses on derivative plays.

Also In December Lloyds Banking Group was fined £28m for “serious failings” in relation to bonus schemes for sales staff. The FCA said it was the largest fine that it or the FSA had imposed for retail conduct failings, thus demonstrating that the problems do not just occur with traders in the investment arms of these banks. Lloyds has now embarked on a trawl of sales to 692,000 customers to see how many may have lost out. Lloyds has already set aside £8bn for mis-selling loan insurance and £400m for mis-selling interest rate swaps. And in 2003 it was fined £1.9m and handed a £100m compensation bill by the FSA for mis-selling so-called “precipice bonds”.

Last month the UK division of South Africa’s Standard Bank Group was fined £7.6m for lax anti-money laundering controls, the first commercial bank penalised in Britain for such an offence. It’s just over a year since HSBC paid a hefty $1.9 bn to settle US charges that it allowed Mexican and Columbian cartels to launder drug proceeds – and lawyers said they expected more penalties to follow. That deal put HSBC at the top of the table for such fines. The top ten looks like this:
 

 

 
To try and understand this better I joined a small group of senior businessmen to listen to Andrea Leadsom MP. She has been described as the brightest of the 2010 intake of MPs and has already joined the Treasury Select Committee. Before going into Parliament she had long experience in the City including being a Director of Barclays Bank PLC until 1997. She then became Managing Director of a successful hedge fund business, and from 1999 until 2009 Head of Corporate Governance for Invesco Perpetual, one of the UK’s largest retail fund managers.

She began by telling us that when the Barings crisis developed in 1995 she was one of the team put together by then Governor of the Bank of England, Eddie George, to telephone all the banks over the weekend and prevent a run on Barings. But by 2007 when the Northern Rock crisis happened George’s successor, Mervyn King took no such action and indeed there was a run on a British bank for the first time since 1866. What had gone wrong with Britain’s banks was an inflated balance sheet. The Bank of England should measure leverage, capital ratios and most importantly, liquidity. Banks like Northern Rock were no better than a Ponzi scheme relying on overnight borrowing. When liquidity dried up they could not meet their obligations.

In the LIBOR scandal Bob Diamond presided over a system where traders fixed interest rates for their own gain. Banks have had to set aside vast sums for the mis-selling of Payment Protection Insurance (PPI); a totally unnecessary cost for most borrowers. There has been SWAPS mis-selling where banks have forced SMEs to take out cover against their default, leading to the premature demise of some companies. There is now an inquiry into the possible rigging of foreign exchange rates which may lead to further enormous fines as with the LIBOR scandal.

One can only conclude that those in charge of these banks have lost sight of the fact that they were set up in the first place with a core social purpose. Barclays was founded by Quakers. But today people on all sides question whether they are doing enough to support economic recovery from the recession they partly caused. The largest have become too big to fail and again people on all sides are looking to set up new challenger banks. In the US there are over 3,500 banks and every year two or three fail. Investors may lose but depositors don’t as deposits are protected to a certain level as they are in the UK.

Andrea thinks instant account portability is one answer.  This would not only help the growth of new challenger banks, but would also stop any run. Her idea is that you would even keep the same account number, just as you can keep your mobile phone number, and she is pushing for this through the Treasury Select Committee. She reminded us of the concepts of free entry and free exit as propounded by Adam Smith in The Wealth of Nations. One sign of a perfectly competitive market, he said, is that there are no barriers of entry and exit thus making it extremely easy to enter or exit a perfectly competitive market. In the UK banking market neither is the case. The barriers to entry are formidable as gaining a license is a long and costly process while the barriers to exit are enormous as we saw in 2008 when the government almost bankrupt itself rather than let RBS or HBOS go under.

I asked her what had gone wrong with the Co-op bank, seen by many as an ethical bank, but which first reported losses of £600m at which point the CEO resigned and then reported a capital shortfall of £1.5bn at which point the Chairman Paul Flowers had gone. Andrea thought this was a classic case of poor governance. The Chairman, who, it turned out, had offences relating to drug dealing and rent boys, was chosen by a committee because of his political background despite no experience of banking. Two deputies with some banking experience had been put in place to shepherd him but they had both resigned before the scandal emerged. Astonishingly all this was done under the noses of the regulators who were clearly asleep at the wheel.

But where does the money from all these fines actually go? Well, in Britain all firms regulated by the FCA have to pay a membership fee to cover the regulator’s costs. Prior to April 2012, the money collected by the FSA went towards reducing these fees, quite substantially so in some years. In effect, then, financial institutions fined by the regulator benefited from lower membership fees, although given that the FCA regulates about 26,000 firms, the numbers involved were pretty small. Since April 2012, however, the money collected from fines has gone straight to the Treasury. Last tax year, after “enforcement fees” of £40m, the government received £341m in fines from financial institutions – not a significant sum relative to the government’s total receipts of about £600bn, but a not insignificant bonus none the less. This tax year the total will be higher still.

The money goes into what is called the consolidated fund, which is effectively the government’s current account for general expenditure. Normally the Treasury does not like to hypothecate its general fund but unusually in this case it has stated specifically that it intends to give money collected in Libor-related fines so far to military charities. In October the government announced that it would pay £35m to the armed forces community, including such charities as Help for Heroes. And in the Autumn Statement, delivered you will recall in the Autumn month of December, the Chancellor announced that a further £100m of Libor-related funds would go not only to “our brilliant military charities” but “to extend support to those who care for the work of our police, fire and ambulance services”. 

I imagine that for most people seeing the money collected from bankers’ dodgy practices being put to good use would be good news. I am not so sure. When you fine a bank what you are actually doing is punishing the shareholders. Very few of the managers responsible have been held to account for their crimes if crimes are what they were. None of the regulators who signally failed to do their jobs has been called to account. Indeed though there are new institutions in place it appears that some of the old faces are also still in place. The shareholders could not know that traders were committing criminal offences but the directors in charge either did know in which case they should pay the price or they did not know in which case they should also pay the price. I am not condoning the banks’ behaviour in any way, but feel that there is now a temptation for the authorities to extract funds from a politically weak target for their own purposes while most of the perpetrators have walked away clutching their fat bonuses.

And there is little evidence that these fines are leading to a change in culture. Antony Jenkins, promoted to clean up Barclays’ image after Bob Diamond, while declining his own bonus for the second year running, has recommended a bonus pool considerably greater than that of the dividends to shareholders. This has attracted criticism from a wide range of commentators and rightly so because it is such bonuses that led to the misbehaviour in the first place.