Banks are not so fine after all

Halloween is almost upon us and banks do not fail to provide their share scary news. Last Thursday investors were scared by reports that HSBC faced a $2.46 billion fine as a result of a Judgment in Securities Fraud Case1. The bad news was quickly followed by US media reporting that JP Morgan was set for a record $13bn (£8bn) fine to settle investigations into its mortgage-backed securities2.

Unfortunately this is not a one-off double hit of bad news as these banks previously faced other significant losses due to law infringements. Last year JPMorgan faced inquiries into a range of its business practices and it has been the target of intense scrutiny over its "London Whale" trading losses, which amounted to $6 billion. In that episode, JPMorgan’s traders in London took risky bets that backfired and two mid-level former employees have been criminally charged. The ongoing stream of investigations and fines has taken such a financial toll that last week JPMorgan revealed it had set aside $23 billion in litigation reserves to cover legal costs3.

Since the 2008 worldwide financial meltdown, other major financial institutions have been at the heart of investigations by UK and US regulators for a number of law infringements, most prominently for the LIBOR fixing scandal4, which also led to significant fines paid by Barclays and UBS5. The scale of this scandal was such that the UK Treasury Select Committee blamed Barclays’ bosses for "disgraceful" behavior which damaged the UK's reputation6.

This string of bad news raises concerns over the effectiveness of internal control within the banks subject to such heavy fines and legal costs. The Corporate Governance section of any major listed corporation includes a description of how the internal control function is managed and of ‘whistleblowing arrangements’ in place in order to prevent mismanagement, corruption and wrongdoings. However, given how easily it seems that laws and rules are broken within banks institutions, it is reasonable to ask yourself where these ‘whistles’ are hid and if there is anyone within these banks actually willing to blow them. And suspicious shareholders might be forgiven for thinking that these whistles are little more than shiny tokens waved in front of less suspicious shareholders in order to reassure them that their investments are carefully looked after.

Besides analysing what causes these internal control failures, it is necessary that stakeholders start asking themselves how to prevent internal control failures which ultimately lead to the significant losses that impact their investments. Of course, the description of internal control management must be improved and cannot be limited to generic terms of reference. The same should apply to whistleblowing arrangements. Lines of accountability should be clearly described in the Corporate Governance sections of the annual reports.

However, better disclosure alone does not guarantee against further failures of internal control. This might not sound that ‘politically correct’, but if a real change in corporate culture is necessary, surely one of the most effective ways to achieve it is to hit executives where they hurt the most, which in the greatest majority of the cases it happens to be their wallets. Including vesting conditions directly 

linked to internal control to executive compensation might give executives a helping hand in changing the culture within the corporation they lead. And that whistles finally blown...