This one is a game-changer. We have got used to the idea that incompetence, greed and hubris led to the banking crisis. But the organised, systematic manipulation of the central reference point of the free market, as exposed by the revelation that Barclays tried to manipulate a benchmark interest rate, casts the global banking industry in a very different light.
The level of arrogance that lies behind the attempt to distort the London interbank offered rate is beyond comprehension. Questions must be asked urgently about the universal banking model. The revelation of trading on the back of organised market deception blows a huge hole in the banks’ claim to police that model effectively. It now looks more likely that the banks were gaming the system when possible, at every opportunity.
We need to know whether several banks were in this together in a formal or informal ring. If so, such an organised rigging of the market would revive suspicions about the existence of a banking cartel. If one market was rigged, might there not be others? Regulators must look again at places where there has been a lack of price competition, for example on new issues and other capital markets business where price protection appears to have been occurring. They will want to look at the method of price formation in over-the-counter markets and “dark pools” where margins for participants can be high, and transparency correspondingly low.
Management control appears to have gone missing. We need to understand why this occurred and how far it spread. This is unlikely to have been confined to one financial institution, for the evidence is mounting that top management at many supposedly blue-chip UK and US institutions failed to see or stop a wide range of egregious behaviour. Practices such as lying about overnight borrowing costs, turning risk management from a business-control mechanism into a profit centre and mis-selling structured derivatives are all symptoms of an industry out of control.
It does not matter whether such behaviour was merely unauthorised or undetected. It shows that the banks as currently constructed are unmanageable and that the warped culture that led to initial public offerings being rigged during the dotcom bubble never went away. Too big to fail? “Too big to manage” and “too big to regulate” now seem equally pressing questions.
Three things need to happen. First, the banks’ integrated business structure needs to be revisited. It is simply not credible to site so many conflicting and connected activities in a single, fluid structure. The UK’s Vickers commission on banking was along the right lines in ringfencing retail banking for prudential reasons, but the industry’s inability to control the flow of information suggests there is a need for a more widespread formal segregation.
Second, the starting point for regulators and banking supervisors should be to disbelieve what bankers tell them. They should be sick of hearing “that was then, this is now”. Senior management appeared not to know or not to care what was going on in their institutions. So the burden of proof must now be on the banking industry to regain public trust.
This is particularly important right now as the industry and regulators work out how to implement new rules on derivatives and proprietary trading. Banking supervisors would be well advised to leave as little as possible to management discretion and to go for bold, simple rules that are easy to understand and possible to enforce. As a codicil to the Libor issue, the role of the British Bankers’ Association, supposedly there to see fair play but evidently asleep at the wheel, surely destroys for ever the industry’s claim to be self-regulating.
Third, the industry has to be serious about cultural change. This means reforms on pay to remove the grotesque incentives that encourage corrupt behaviour, and the introduction of an ethical code consistent with the business model. There is no point telling staff the client comes first and then rewarding them on the profit they make for the firm. Senior managers must make it clear the institution’s first responsibility is to the integrity of the market and the interests of the client. Corporate profit and individual compensation is the outcome of such behaviour not its motor.
Will such radical changes be implemented by a generation that has grown up under the old cultures? That is extremely doubtful.
The writer’s books include ‘The Greed Merchants: How the Investment Banks Played the Free Market Game’