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Bringing the banks to account

It began as a trickle but has turned into a flood. HSBC, Barclays, Wachovia, JP Morgan, and UBS have all been engulfed by waves of scandal involving, money laundering, fixing interest rates, risky trades, and rigging the money markets. The question now is – have the banks gone bad? The claim by senior bank executives they ‘we did not know’ rings hollow, and must not be allowed to stand if they are to regain their integrity. 

The banks have long resisted greater hands-on supervision of their activities, but the recent rash of publicity surrounding their bad conduct proves that left to their own devices market discipline is not enough. Their involvement in dubious transactions, including in greasing the wheels of corruption through money laundering requires the full implementation of existing rules and regulation, and empowered supervision. The World Bank’s Stolen Asset Recovery Initiative (StAR) along with Financial Market Integrity (FMI) have long pressed for the banks to do more to prevent money laundering and to fight corruption.  As a rough estimate, it is believed that $20 – $40 billion is stolen from the coffers of developing countries every year. Much of it ends up being laundered through the banks, passing through financial capitals around the world en route to the beneficiaries. Mechanisms to detect illicit cash flows have long been in place, but the existing system is not working, and corruption is eating away at the foundations of the banking system.

A recent talk hosted by StAR and FMI illustrated the reality of money laundering and the dangers it poses. The speaker, Robert Mazur, came with solid credentials having worked as an undercover US Federal Agent involved in money laundering for the notoriously ruthless Medellin cartel.

Mazur recalled his time undercover spent dealing with crooked bankers and businessmen, peppering his talk with images of suitcases stuffed with cash, bricks of cocaine piled high and a succession of mug shots of those involved in the drug trade and money laundering. He spoke of the way that his efforts contributed to bringing down the Bank of Credit and Commerce International, the seventh largest privately held bank in the world at that time. But in recalling the past, he emphasized that for the banks, “a lot of what was going on then is going on now.”

Given the evidence currently on display, Mazur’s assertion in indisputable. Recent revelations of money laundering by HSBC, the fixing of ‘Libor’ rates by UBS and Barclays and other scandals have come thick and fast, with more expected to follow. Some will cite the ensuing financial penalties ($900 million for HSBC, $1.5 billion for UBS and $450 million for Barclays) as proof that the misdeeds of the banks are being taken seriously. But the fines have had minimal effect upon the banks’ bottom line (HSBC’s penalty only represents ten per cent of net profits for one year).

What then, about greater regulation and government involvement? Sweeping additions to regulations while tempting are unnecessary and ultimately harmful to the banks. The key failure is the lack of enforcement of what already exists. Only on some key critical issues (such as politically exposed persons (PEPs) and beneficial ownership) is additional regulation needed. A recent study by StAR revealed that governments and financial institutions have been unwilling to implement existing standards against corrupt ‘politically exposed persons’. It revealed that over sixty per cent of the countries signed up to the Financial Action Task Force (FATF) were not compliant with the regulations. Another StAR study, ‘The  Puppet Masters’,  also highlighted the failure of many governments to apply existing rules regarding the real beneficiaries of dubious shell companies and other legal structures set up to hide  illicit funds. To set matters right, supervision must be taken seriously, and carried out wisely to ensure that those responsible for implementing the rules– the institutions and the personnel - are held fully accountable.

For national institutions and economists the integrity of the banking sector is a shared and growing concern. A recent World Bank event brought together Tracy McDermott from the British regulator, the FSA, Luis Corral from the Bank of Mexico and Nicolas Veron, a French economist from the European think-tank, Bruegel. The participants all agreed that something had to be done to improve the integrity of the banks, but they differed in the extent and way that prudential supervision should be applied. Tracy McDermott talked of the difficulty in getting the right oversight in different jurisdictions, stating that, “there is no toolbox expected to work under any circumstances”, while Nicolas Veron warned how ill-considered regulation could undermine confidence in the banks. But whatever their differences all agreed that the current situation could not continue.

Looking at the banks today, it is clear that without their services in facilitating the movement of dirty cash from embezzled state funds, bribes and other transactions, corruption would be much more difficult. Action is needed on all fronts. Banks must up their game in checking the background of customers and the origin of their funds. Supervisors can and must do more to enforce compliance with anti-money laundering rules. Law enforcement must increase its capacity to investigate and trace illegal funds, and go after not just the criminals but those who enable their activities.  This will require action from developing countries to ensure a robust independent supervisory mechanism and a financial sector free from undue political influence. At the same time the developed world can no longer continue to turn a blind eye to its role as a safe haven for corrupt funds. Unless and until there is concerted action, we can expect more headlines and more damage to a banking sector that is increasingly tainted.