Out-of-court settlements with errant banks: Is

financial services industry on a dying path?

Banks are at the receiving end-August 25, 2014
The reports coming from global nancial markets are not good for banks at
all! Banking regulators have rene"ed their "ar against "hom the# perceive
as errant banks! The la" enforcement agencies in their respective countries
too have $oined them as allies in this onslaught! This time it is not small
banks "hich the# have captured in their nets! %t is big banks the# have
netted proclaiming &no bank is too big to $ail', the alternative version of the
popular dictum &some banks are too big to fail'!
This
sudden onslaught of banks b# both regulators and prosecutors has
shattered the foundation, long believed to be rm and strong, of the
banking industr#! Banks too admitting their guilt have started to arrange for
&out-of-court settlements' to avoid eventual bigger losses! (ne b# one, all
leaders in the industr# have added to their collection of nes,
compensator# pa#ments and lump sum customer protection charges! %n the
process, banks have got out of a mess# situation! But, no amount of
compensator# pa#ments can restore them "ith lost credibilit#, trust and
reputation "hich are the core pillars of a sound banking industr#!
An out-of-court settlement "ith a price tag of ) 25 b
According to *ational Association of Attorne#s +eneral or
*AA+ , an association of -. /rosecutors set up in 1001 , the
latest out-of-court settlement has forced ve leading banks to
pa# as much as ) 25 billion 2available at3
http344naag!org4state-attorne#s-general-feds-reach-25-billion-
settlement-"ith-ve-largest-mortgage-servicers-on-
foreclosure-"rongs!php5! The ve banks under attack b# -.
/rosecutors have been the largest in the "orld3 Bank of
America, 6 / 7organ 8hase, 9ells :argo, 8itigroup and All#
:inancial! These banks for "rongs done to homeo"ners b#
taking over their homes "hen the# "ere unable to repa# their
loans , kno"n in industr# as &foreclosure' , have agreed to set
aside ) 25 billion as compensation as follo"s3
nA minimum of ) 11 billion "hich can go up to ) ;2 billion b#
"a# of direct relief to borro"ers including the reduction of the principal sum
of the loan<
nAnother ) ; billion to
renance the borro"ers
"ho have been forced to
sell their homes belo"
the borro"ed cost at a
penn# due to the adverse
market changes , a
situation kno"n as
&under"ater mortgage
sale', earning its name
from a propert# "hich has
gone under "ater and
therefore no value to a
bu#er<
nA pa#ment of a ne of )
5 billion to state and federal governments in -.A!
The ob$ective of being tough on ve leading banks has been to protect the
consumers , the goal of a bank regulator# method kno"n as micro-
prudential regulation! As e=plained b# %o"a Attorne# +eneral Tom 7iller the
>goal has been to hold banks accountable "hile providing urgentl# needed
relief to homeo"ners and transform a badl# broken s#stem into one that
protects borro"ers?! %t is no" clear that the countr# prosecutors are more
concerned about consumer protection than upholding the banking s#stem
stabilit#! %n this scenario, banks have to undertake a critical balancing $ob
bet"een consumer protection and long term protabilit# $ust like an acrobat
performs a tight rope "alk! %f the# tilt to either side unnecessaril#, the# "ill
fall o@ the rope to their o"n peril!
Aeav# punishments imposed on banks
This is $ust one settlement among man# "hich the industr# has reached
"ith respective countr# regulators! .ince the global nancial crisis of
20014B, bank regulators have been tough on banks and have imposed
penalties for a variet# of misdeeds the# are alleged to have committed!
These misdeeds cover a "ide range3 =ing interest rates , especiall# the
benchmark interest rate in the nancial markets called Condon %nter-Bank
(@ered Date or C%B(D, helping mone# laundering, risk# trading in
derivatives and =ing of markets for commodities! %n this long list of sins
attributed to banks, =ing of C%B(D and its counterparts in Een and Furo has
caused big banks to pa# nes or out-of-court compensations up to ) G
billion from end 2012 to mid 2014 2available at3
http344"""!value"alk!com420144054large-bank-libor-liabilities4 5!
7ishandling of mortgages to the detriment of homeo"ners and renancing
agencies has resulted in pa#ing nes and out-of-court settlements, in
addition to the above mentioned -. ) 25 billion, amounting to ) ;0 billion
2available at3 http344blogs!"s$!com4mone#beat4201440G42;4a-list-of-the-
biggest-bank-settlements4 5! The total so far imposed on banks over the last
three #ears has amounted to ) 10 billion, "ell over .ri Canka's +H/ of ) G1
billion! These are huge sums about "hich man# in civil societ# bent on
punishing errant banks "ould take relish at! Ao"ever, the punishments
have been imposed on a leading industr# in the globe "hich has long been
praised for its innovativeness, creativit# and support for global economic
gro"th! Aence, some"here something has gone "rong and it lies be#ond
the nes imposed on and out-of-court settlements arranged "ith those
supposed to be errant banks!
*eed for looking be#ond punishments
Ao" could an industr# so vital to a health# global econom# emerge as
culprits in the e#es of the public, regulators and countr# prosecutorsI 9hat
"as the contribution made b# banks themselves to their current
predicamentI 9hat "as the contribution made b# the bank regulators for
the errant banks to misbehave and eventuall# come clean b# pa#ing
thumping compensator# pa#mentsI These are interesting issues to be
sorted out since the current "ave of cleaning bank balance sheets through
forced settlements does not cure the ailments from "hich the industr# is
su@ering!
At least t"o reasons could be adduced to the current malad#! (ne is the
regulator# forbearance on the part of the regulators! The other is the
regulator# capture b# those supposed to be regulated b# regulators!
Banking regulators failing to act in time
Degulator# forbearance is the failure of regulators to take timel# action on
an errant bank "hen the# come to kno" of "rong things happening in it! %n
the case of banks, the regulator is usuall# the central bank of the countr# or
in some cases, an independent nancial services authorit#! The# gather a
large amount of information from banks themselves through regular reports
, kno"n as o@site surveillance , and b# making on the spot e=aminations ,
kno"n as onsite supervision! %n both cases, information is provided b#
banks themselves and it is in the interest of the information provider, in the
absence of an# penalt# for suppl#ing false information, to suppl# onl#
partial information or information benecial to him! %n economics, this is
kno"n as as#mmetric information "here a bank kno"s ever#thing about
itself "hile the central bank kno"s onl# "hat is supplied to it!
%f central banks are not tough on banks "hich suppl# partial, "rong or onl#
favourable information, there are all the incentives for banks to keep on
suppl#ing "rong information to the regulator! Ao"ever, there are t"o other
valuable sources of information "hich central banks cannot ignore! (ne is
the market rumours about nast# things happening in banks! The other is
the anon#mous informer , kno"n as the &"histleblo"er' , "ho keeps on
sending a Jo" of information to the regulator! The "histleblo"ers "ould
have been guided b# ill-"ills in blo"ing the "histle! Eet, the pieces of
information the# suppl# are ver# vital for a central bank to Kuickl# act on an
errant bank after due investigations!
9hen central banks come under political pressure not to act
The reasons for practising regulator# forbearance b# central banks are
numerous! The# ma# be under political pressure not to act on errant banks
"hich are related to top politicians or "hich have successfull# captured the
politicians! Fven if a central bank does not come under political pressure, it
ma# still refrain from taking action due to its o"n ineLcienc# or ineLcac#
or sometimes due to prestige reasons! Third, central banks ma# be
concerned about the large social costs that ma# be imposed on societ# b#
allo"ing a big bank to close its doors! A situation "here depositors form
themselves into associations and threaten to commit suicide in front of a
central bank is nast# and should be avoided!
9hatever the reason, regulator# forbearance contributes errant banks to
thrive and once the s#stem is plagued b# such banks, a massive operation
has to be launched in order to protect the banking s#stem! This is "hat the
%o"a Attorne# +eneral has referred to as the &broken s#stem' though he has
failed to mention "ho had contributed to break the s#stem in the rst
instance!
Degulator# capture3 The "orst public enem#
Degulations are imposed b# governments , banking regulations are one
such form , to correct the market failures and protect the consumers!
Ao"ever, ever# instance of regulation is marred b# desires of interested
parties to capture the regulators and get them to "ork for them, instead of
"orking for societ#! This "riter in a previous article under the title
&Degulator# 8apture3 The "orst public enem# imaginable' in this series
anal#sed the malad# of regulator# capture 2available at3
http344"""!ft!lk4201;4024044regulator#-capture-the-"orst-public-enem#-
imaginable45!
%ncentives for capturing regulators
%t "as the Aarvard -niversit#'s political scientist .amuel /! Auntington "ho
rst came up "ith the idea that interest groups have incentives to inJuence
regulator# agencies in a paper published in 1052! But the formal
development of the concept in terms of economics "as done b# 8hicago
-niversit# economist and *obel Caureate, +eorge 6! .tigler, in 1011in a
paper published in the Bell 6ournal of Fconomics and 7anagement .cience
under the title &The Theor# of Fconomic Degulation'!
The term regulator# capture "as not coined b# .tigler, but b# another
political scientist, 7arver A! Bernstein, formerl# at /rinceton -niversit# and
at that time /resident of the Brandeis -niversit#, in a paper published in
1012! %n this paper titled &%ndependent Degulator# Agencies3 A /erspective
on Their Deform,' Bernstein said that >most familiar charge against
independent commissions is that the# develop an orientation to"ard the
vie"s and interests of their clientele and become ripe for capture,? thereb#
giving birth to the term regulator# capture!
Toda#, the regulator# capture theor# in public polic# is a "ell established
proposition and it represents the main arguments presented for establishing
the failure of the government! Aence, the need for eliminating the same in
the public polic# s#stem is as important as eliminating briber# and
corruption , another important source of the government's failure!
8apturing regulators
Bank regulators and politicians above the regulators are captured b# big
banks in order to dilute the regulator# mechanism for their benet! 9hile
politicians are cultivated for capture through re"ards, bank regulators fall
pre# to their craft# schemes due to deciencies in their kno"ledge base!
%t is usual in man# countries, the resource persons for central banking
training courses are provided b# big commercial banks! 9ith this kno"ledge
superiorit#, "hen commercial banks come for discussions, the central bank
oLcials are at their merc#! The result is that banking regulators act not for
the protection of the s#stem, but for the benet of banks "ith "hich the#
have developed close relationships!
+ullible public believes that regulations are good
Banking regulations are introduced "ith so much of hopes at the time of
introduction! But the# become perverse to the societ# over the natural life
span of a regulator# agenc#!
This happens "hen the regulator# agenc# allo"s itself to be captured b#
interest groups!
Though this is a "ell kno"n fact, the demand b# politicians and the public is
for more and more public policies and regulations! The politicians do so
because the# stand to gain!
The public does so because the# are made to believe that regulations are
for their benet through e@ective propaganda "ork that arouses patriotic,
nationalistic or religious feelings!
Ao" to limit the regulator# captureI
After the bad e=perience "ith regulator# capture in the last centur#, an
independent think-tank called The Tobin /ro$ect based in 7assachusetts in
-.A implemented a special pro$ect on regulator# capture in 2000! %ts report
titled &/reventing Degulator# 8apture3 .pecial %nterest %nJuence and Ao" to
Cimit %t' has been released in 201; b# the 8ambridge -niversit# /ress!
The papers in the volume have been released to the "eb for free use b# the
interested scholars 2available at3 http344tobinpro$ect!org4books-
papers4preventing-capture5!
These papers have argued that to limit the regulator# capture, consumer
groups have to be empo"ered to check on the inJuence of the industr# on
regulators, the court s#stem should be strengthened to revie" the
regulator# action and declare "hether it is legal or illegal and a central
revie" s#stem of the regulator# action should be established "ith po"ers to
look at the regulator# "ork from both prospective and retrospective points
of vie"!
/reventing regulator# capture
.ince the consumer groups, $udiciar# and central revie" agencies can also
be manipulated b# the special interest groups, especiall# all po"erful
political authorities, the "hole issue boils do"n to three basic reKuirements
to be put in place! The# are the observance of the Dule of Ca", the
preservation of the independence of the $udiciar# and respecting the "ork
done b# both formal and informal institutions that have dedicated
themselves to eliminate the possible regulator# capture b# interest groups!
Act in time to prevent misdeeds of banks
Banks are being punished toda# partl# for the ills of banking regulators and
partl# for the sins committed b# them! /a#ing high compensator# pa#ments
"eaken the banking s#stem and the ta=pa#ers "ill be eventuall# called
upon to rescue them at a greater cost! Timel# action b# banking regulators
is therefore more important than imposing nes on the errant banks!
29!A! 9i$e"ardena, a former Heput# +overnor of the 8entral Bank of .ri
Canka, can be reached at "a"1040Mgmail!com!5