If bankers are to lose their heads so too should lax politicians
Mismanaging a financial institution to the point of collapse is no more an offence than mismanaging a butchery or a bakery to the same point, writes Colm McCarthy
PROPOSALS from the Central Bank last week that company law and regulators’ powers should be expanded to include tailor-made sanctions for managers of failing banks need some justification. Why pick on banks? Do not the market, and the universal sanctions of the corporate code, contain sufficient penalties for errant executives?
Any commercial company that goes bust inflicts collateral damage on innocent bystanders. The company’s shareholders lose, the creditors lose and employees and pensioners take a hit. Sometimes it can be just down to bad luck and the vagaries of business life. But quite often the boards and management get it badly wrong. Of course boards and management lose too, both jobs and reputation, and usually lose more than many of the bystanders.
But banks are different from ordinary commercial firms: the bystanders, in a major banking bust, include just about every citizen, even future generations. The portion of total losses absorbed by boards and management when a bank goes down is often fairly modest. Governments almost always feel impelled to rescue failing banks and to revive faltering banking systems. No such indulgence is generally available to the butch er, the baker or the candlestick maker. Their failures are regretted but rarely reversed: there are never enough casualties to justify the deployment of the State’s finances.
For a bank to go bust two things need to happen simultaneously: the bank needs to make careless investments, especially in the loans it makes, and it needs to have inadequate capital in reserve when the ill-chosen borrowers begin to default. These two straightforward points have been well understood for at least the last hundred years and most countries have stringent licensing, regulation and supervision systems for banks. Why these systems failed in the first decade of the new century will preoccupy economists and financial experts for a generation.
The banking systems in most of Europe and in the USA saw numerous large banks go bust during the Great Financial Crisis from 2007 onwards and the Irish bank bust was one of the most destructive. Every significant bank went under, in itself an unusual occurrence, and the economic damage, relative to the size of the economy, was higher than almost anywhere else. It was also the first large-scale banking collapse in Irish history — the transition, in the decade or two leading up to the crash, from a and conservative banking market to a spectacular bust also has few precedents.
In every country where state funds were mobilised to rescue financial institutions there were loud demands that heads should roll, particularly the heads of bankers. There have been prosecutions in many countries, mostly for events which occurred subsequent to the crash, and heavy fines running to hundreds of millions have been imposed on a range of international banks for rigging the wholesale money and foreign exchange markets, for money-laundering and for mis-selling retail financial products. Some bank staff have been jailed, especially in the USA, for insider trading and other specific offences. But nobody has been charged with running a bank so poorly that it went insolvent and required State rescue, for the very good reason that mismanaging a bank to the point of collapse is not an offence, any more than is the mismanagement of the butcher or the baker.
Notwithstanding the heavy fines imposed by regulators on banks in the USA, the United Kingdom and in several continental countries, there remains a degree of public dissatisfaction, a perception that there has been inadequate punishment for banking failures. The impressive fines on the big international banks, after all, are paid by passive shareholders, not by top management. But managers responsible for the worst failures have nearly all lost their jobs, even if they have escaped legal sanctions.
Is there a case for holding top management in financial institutions to a higher standard than managers of other industrial and commercial companies? General company law penalises management misbehaviour in all sectors. It is illegal, in any line of business, to defraud people or to knowingly trade while insolvent. Is there some practical reason to hold executives in large financial firms to a higher standard?
Last week the Central Bank of Ireland published its response to a January 2016 report on these matters from the Law Reform Commission. The Central Bank has recommended that there should indeed be a more demanding regime for managers in banks and insurance companies than for the managers of a bakery. The essential reason is that the general public is not exposed to the unsuccessful bakery, either as creditors or as involuntary suppliers of rescue funds in a bust. The bakery managers face regulation (from the food safety people) but nobody polices the adequacy of their liquidity or the quality of their debtors’ ability to repay. There are very limited repercussions for most of us if the bakery managers screw up. But most of us are creditors of the banks, since almost all of the money stock in advanced countries takes the form of bank deposits. The banks also run the payments system and supply most of the credit in the broader economy. If a large bank goes bust, never mind all of them, it is a national crisis. If a large bakery goes bust, it is just a pity. Poor management of banks will impact on a far larger circle of innocent bystanders, and no government can contemplate the rapid destruction of both money and credit consequent on a refusal to rescue.
So large banks, and more precisely their creditors, have enjoyed a ‘too big to fail’ free insurance policy from the taxpayers. Virtually no significant bank in any of the advanced economies was allowed to collapse, although creditors of failing banks took rather more losses in the USA than elsewhere.
In Ireland bank shareholders lost almost everything, some categories of bank bondholders took a hit but no depositor lost a penny. No democratic politician ever finds it easy to translate ‘screw the banks’ into the logical corollary of ‘screw the depositors’. Don’t hit me while I’m holding the child.
Insurance company managers also operate in a kind of fiduciary relationship with the broader public. Premiums are paid upfront and the public goes uninsured, having paid in advance, if the company mismanages its way to insolvency.
The collapse of Quinn Insurance would have been a sensational story in Ireland had it not been overshadowed by the even more sensational banking disasters.
The public understands that it will be burdened with State debt for a long time because the banks went down but it will also be burdened with surcharged insurance premiums to pay for Quinn, whose creditors (those who paid the upfront premiums) were bailed out.
The regulators, as well as the management, failed to protect the financial sector’s sleeping partners. Governments act as if the credit of the State itself, the credit of the citizens collectively, is at stake in the executive suites of large banks and insurers.
If this justifies bail-outs for these institutions when they fail, and exceptional legal standards for their managers, it justifies penalties too for the indulgent regulators and politicians who slept through the disaster.
‘Managers responsible for the worst failures have nearly all lost their jobs’