Since the onset of the global financial crisis in 2007 a lot of thought has gone into questioning both the merit and integrity of financial and economic theory underpinnings, the approach to global and domestic financial regulation and their cross-border interaction and governance and inherent ethics in the financial sector.
The cumulative direct and indirect cost of the global financial crisis up to 2010 was estimated at as much as 40% of global GDP of that year.1 More recently, over the past two years we have had a series of governance failures that rocked the financial services industry at a time when trust was already eroded. These included the recent electricity market, LIBOR, mis-selling of payment protection insurance and money laundry scandals with Barclays, RBS, HSBC, Standard Chartered among others being implicated and facing regulatory fines in the order of hundreds of millions. Against this backdrop, a high level panel held at London Business School on 1st November 2012 debated the structural challenges faced by bank boards and proposed a set of recommendations to enable boards to do a better job.
Bank boards as compared to the boards of industrial companies have a huge responsibility; employees well below executive and senior management level can alter the risk profile of a bank substantially and over a short time horizon. In addition bank boards are faced with key structural industry issues that pose substantial challenges:
i) too big to fail and too big to save institutions;
ii) blended asset pools with no ring fencing;
iii) high leverage and low capitalization;
iv) moral hazard;
v) absence of living wills for orderly resolution; and
vi) universal banking activities covering a wide array of products and services.
To help mitigate these structural flaws and enable boards to do a better job a number of areas of action can be pursued.
These include assessing the utility of having large universal banks; enforcing less risky levels of leverage and improving capitalisation of the industry. Putting firewalls to ensure the effects of contagion are minimized in the case of failure. Altering fiduciary duties of the board of directors to cover all stakeholders including debt holders and taxpayers. Hold boards accountable for the safety regime in their banks potentially with members facing imprisonment if they are proved negligent. Giving debt holders rights pre-distress and pre-bankruptcy. Appointing an ‘ethicist’ at each bank as one of the industries most vulnerable to the impact of poor ethics on its livelihood. Restructuring compensation to ensure sustainability by evaluating performance based on economic returns and on a risk adjusted basis. Discouraging excessive risk taking by linking bonuses to credit quality metrics and introducing appropriate claw backs and longer lock-up periods. Better distribution of a bank’s economic profits among the various stakeholders, for example in 2011 Barclays employee costs were more than 10 times whatever it paid out to shareholders in dividends, a pattern observed across several other banks. Segregate bank chairman and CEO positions to ensure a better balance of power between board and management. Finally, enhance transparency to enable market discipline and external governance to kick in.
The Panel was moderated by Daniel Schäfer, Investment Banking Correspondent with the Financial Times. London Business School finance Professors Julian Franks and Stephen Schaefer, Clare Spottiswoode, Ex-Commissioner on the Independent Commission on Banking and George Dallas, Corporate Governance Director at F&C Management. Professor Francesca Cornelli, Term Chair Professor of Finance, also gave some introductory remarks.
1 Towards a New Model for Early Warning Signals for Crises: An Application to OECD Countries. Casu, Clare, Saleh, 2011.