It’s been a tough decade for the banking industry. Maximilian Turunen discusses the lack of initiative in the sector and how banks can learn from others, such as cryptocurrencies, to drive positive change.
The cost of the regulatory response
The response to the financial crisis, especially from the public and the regulators, has not been kind to the banking industry. The occurrence of the crash itself led to a breakdown of public faith in banks. While this was brought about by undoubted instances of bad behaviour, the whole industry has since been struggling to grapple with both the reputational and regulatory response ever since.
The consequences of the regulatory response are having an unprecedented impact. The implementation of different aspects of regulation has squeezed both the human and financial resources of firms for over a decade now. The proportion of revenue spent on managing the ever-more complex regulatory requirements, essentially to just keep a firm’s head above water, is eye-watering.
As major investment banks operate across multiple jurisdictions, the divergent requirements of different regulators only add further complexity. Regulatory divergence is having a significant impact. According to a Financial Times poll of 250 financial services executives, a patchwork of territorial global regulations has cost banks’ $780 billion – or 10% of revenue.
High regulatory costs
Association for Financial Markets in Europe (AFME), the industry association for wholesale banks, asked 13 large banks about their annual regulatory costs: the reported regulatory cost on their capital markets activities every year is $37 billion in aggregate.
Apportioning so much energy to the regulatory response detracts from other, more productive and forward-looking activities. Attention to more strategic, long-term developments suffer as a result – from improving offerings through to driving efficiencies across businesses and the execution of those services.
Have banks brought on the pain themselves?
Tightened regulatory scrutiny has been a natural, and in many ways, an expected consequence of the financial crisis and the events and practices that underpinned it. As an industry, we must concede that one of the reasons for the avalanche of conduct regulation is the fact that banks have been caught behaving in unacceptable ways. A recognition of the fact has not been adequately reflected in the industry’s response to the financial crisis.
The interests of banks have, in many instances, prevailed over the interests of clients or the wider market. In some cases, the commercial, profit-led interests of banks have stretched beyond the parameters of the law. The revelations of mendacious inflation/deflation of interbank rates during the London Interbank Offer Rate (LIBOR) scandal is just one example of how major banks lost the trust of the public. This is not to mention the myriad money laundering scandals still unfolding across the world.
A defensive response is understandable – especially from a bank that considers itself to have been unfairly tangled up in the response to the misdemeanours of its peers. Recognition of the fact that banks are in this collectively, as an industry, is a key factor in coming up with a more effective, future-proof response that will garner the trust of the public.
Conduct regulation has been a hard nut to crack
Looking at conduct regulation, it would be fair to say some aspects have been heavy-handed. The Markets in Financial Instruments Directive or MiFID II is the most obvious example – it includes a plethora of provisions that banks were required to implement in order to protect the retail investor. However, the all-too-familiar industry retort is that it takes super-human effort to get to the bottom of the (sometimes obscurely worded) provisions. Provisions which don’t always directly apply to those banks that spend most of their time interacting with professional clients and eligible counterparties, such as investment banks.
Furthermore, trying to get investment banks to introduce procedures for complaints and to provide assurance on their products, has been viewed by many in the industry as an unnecessary and futile response to a much bigger problem. Such provisions are likely to have unintended consequences, not limited to an increase in all-in prices of financial instruments. As an industry, we must ask why this set of prescriptive regulation has come about, instead of bemoaning the regulatory response. By doing so, we might conclude that the lack of proactivity from banks has indeed fuelled the issue.
The industry (not the regulator) is the answer to a healthier market place
Certainly, the industry has already expended some effort in working out what good market practice looks like. By adopting existing codes of conduct banks can demonstrate to the regulator and to the wider market that they are taking active steps to deal with some of the arising issues. Additionally, this is a good way for senior managers to prove that they take personal responsibility for the conduct of their firms seriously. Even so, some institutions still have a long way to go to catch up with this standard of good practice.
Proactivity is the banking industry’s key to eradicating the burden of counterproductive regulation. An interesting example is the way cryptocurrencies have established their own code of practice in the UK. In a proactive attempt to bring both transparency and legitimacy to a sector that has been shrouded in controversy, seven cryptocurrency firms have set up their own standards for market practice.
In doing so, they have tried to engage the regulators and policy makers to shape the policy blueprint themselves. In this sense, cryptocurrency firms are attempting to avert the potentially harsher – and certainly more time-consuming – prescriptive measures that might otherwise be imposed upon them by the regulators. The banking industry could learn from this.
How to drive positive change
1. Conduct the Daily Mail test
Challenge existing practice through the Financial Conduct Authority’s (FCA) principles. By viewing the FCA as a partner rather than just a necessary body, you can apply the FCA’s principles to new scenarios and markets in helpful ways. They can be used as a constant resource to challenge your own internal practices. Think about the impact of your business being plastered across the front page of the Daily Mail.
2. Engage peers
Better engagement with industry associations will be beneficial for the whole industry. This will enable banks to settle on what constitutes good/best practice alongside their peers – and create a new image of an industry that is constantly improving. Naturally, this will be viewed positively by the regulators and go a long way to recovering the poor perception from customers and the wider public.
3. Test for weakness
Carry out internal testing to focus on resolving areas liable to conflict and bad client outcomes. Work internally to assess where the big conduct risks are. A good place to start is the properly formulated conflicts of interest registers most banks have collected over the past years. Test which of these weaknesses might crystallise into real issues and act on them.
The objectives of most banking executives are the same as those of the regulators and the public at large: the integrity of the market place, that good practice is transparently adopted by all key participants and that the end investors receive adequate protections and good service from their representatives and intermediaries. To this end, the industry must challenge itself more robustly and implement codes of conduct that put an end to the bad practice of the past and inform the best practice of the future and do so proactively.