As if the furore over the manipulation of Libor were not enough, another scandal has just broken out in UK banking.
The Financial Services Authority has found that all four leading commercial banks — Barclays, HSBC, Lloyds and Royal Bank of Scotland — committed “bad practice, including possible mis-selling” of interest rate derivatives to small and medium-sized enterprises.
This included selling structured collars to SMEs that may not have fully understood the potential losses they could incur; not properly explaining the break costs of swaps; and virtually forcing customers to buy hedges by threatening to deny them a loan otherwise.
It is too early to tell how widespread and grave these malpractices were. They may turn out to have been uncommon. However, the FSA is concerned that the behaviour goes beyond a few isolated cases and forms an industry-wide pattern.
The regulator has done a two month preliminary review, and will now investigate further. It will also examine the activities of smaller banks, and is encouraging SMEs to come forward with complaints.
Some things are already clear.
Reputationally, this is disastrous. Barclays — and the other banks that are likely to follow it into in the glare of the Libor spotlight — may have hoped to claim the rate-fiddling was a one-off lapse. That line of defence will be fatally undermined, in the eyes of public opinion, by this other, completely separate, outbreak of abuse.
In their fight for public support against their critics, the UK banks are now reeling back on the ropes. Prime minister David Cameron has announced a six month parliamentary review into banking standards, which will not be limited to the Libor abuses — also covered by a separate inquiry.
MPs will be pummelling bankers and regulators for months.
All this will be going on while the government is preparing two bills to reform financial services — including the Banking Bill, which will implement the Vickers Committee’s recommendations of ringfencing UK retail banks.
Any hopes the banks had of watering down those proposals must now be dwindling. Indeed, more voices are now calling for stronger measures, such as a Glass-Steagall-style separation of commercial and investment banking.
Bankers should not feel self-pity. The derivative mis-selling claims — even if they turn out to be limited in scope — are shocking, and in a different way from the Libor and Euribor manipulation.
It is possible to imagine that Libor submitters may have felt changing their quote by a few basis points, or fractions of basis points, was a victimless peccadillo. Sixteen banks were involved in setting it — what influence could one bent quote make? If all the other banks seem to be massaging their quotes to avoid any sign of distress, why shouldn’t we?
The whole area was unregulated and based on a tradition in which the submitters had to exercise their judgment.
Mis-selling derivatives to SMEs is completely different. Every banker involved in selling such products is aware of the risks of mis-selling. There is a whole body of regulation surrounding it. If a bank was in any doubt, it could have consulted the FSA.
If banks overstepped the line here, it was with their eyes open — and looking straight at the victim. That some SMEs were shoddily treated for the banks’ gain blows a hole in their PR claims to be supporting the economy and financing job creation.
Rigorous enforcement action is needed to remedy this problem and to prevent recurrences. But that is not enough — such behaviour was already prohibited.
The public, politicians and regulators will conclude — and banks will, if they are honest, admit — that, once again, the profit motive and banks’ internal incentive structures have led them to ride roughshod over ethics.
It must be recognised that the banks’ drive for double-digit shareholder returns and high pay is itself a permanent threat to the kind of standards that the public expects in commercial banking.
Bank CEOs must either tell shareholders to expect lower returns, and make conservatism their watchword, or split their more humdrum commercial businesses from the high-rolling trading and investment banking activities.