Comment: Breaking the banks

WHEN Jim McGrory raised a loan to buy a guesthouse in St Andrews he hoped it would be a business he could one day hand on to his children. The 67-year-old borrowed £562,000 from Clydesdale Bank to buy the property and two others, and was soon the proud owner of the nine-bedroom Arran House Hotel.

But it was also the beginning of a nightmare relationship that has left him nursing huge interest payments after the bank encouraged him to take out an expensive hedging product – and a bill for £88,000 if he should try to break the contract. Now, instead of leaving his family an inheritance, they’re looking at a potential six-figure debt to pay off the bank.

“The banking culture is based on greed and deception,” says McGrory. “They are basically saying, ‘how much money can we suck out of the customer?’ ”

His story is one of thousands of similar cases of individuals who claim they have been mis-sold products that have helped to inflate bank profits and line the pockets of those at the top. Months of inquiries into banking malpractices culminated last week in two hugely critical reports of those who ran HBOS and Barclays, while shareholders served a £4 billion writ on the Royal Bank of Scotland and four of its former directors.

Barclays’ top bankers considered themselves beyond the rulebook, while HBOS management were attacked for their catastrophic failings. RBS and its directors are accused of misleading investors at the time of a big fund-raising exercise five years ago.

Amid all the criticism, questions were being asked about how they could have been so reckless and, in the case of HBOS, so stupid. But a key issue for many critics was the extent to which the banks have made any real attempts to change their behaviour. Although cultural change is firmly on the agenda in all the banks, many observers believe it will be the hardest thing of all for the banks to achieve.

André Spicer, professor of organisational behaviour at Cass Business School, says banks face a profound change in moving from a high-risk, high-reward culture to a more staid business model. While cuts to contentious areas such as bonus pay can be implemented relatively quickly, shifts in “softer” areas such as conduct can take years to take hold.

“It would be really naive of us to expect an overnight change in ethos,” Spicer says. “It takes a long time for people to drop a culture that they have been trained in and which they have been rewarded for over quite some time.”

If any reminder of the failings of the UK banking sector in the run-up to the financial crash of 2008 were needed, it arrived on Friday in the form of a report published by Westminster’s Parliamentary Commission on Banking Standards. The report of an investigating group of MPs and peers unleashed a savage attack on the bankers who led the previously lauded Bank of Scotland and Halifax, then Britain’s biggest building society, into a merger and then to a multi-billion-pound taxpayer bail-out to prevent it, like RBS, from going under. The language was merciless. “The weaknesses of group risk in HBOS were a matter of design not accident,” it said. “Consumers and the wider economy as well as shareholders and taxpayers have paid a heavy price for the blunders of the HBOS board,” it added.

Twisting the knife into senior management, it went on: “The primary responsibility for the downfall of HBOS should rest with [chief executive] Sir James Crosby, architect of the strategy that set the course for disaster, with Andy Hornby [Crosby’s successor] who proved unable or unwilling to change course, and Lord Stevenson [the chairman], who presided over the bank’s board from its birth to its death.”

Corporate governance, the report proclaimed, was “a model of self-delusion” while it was a matter for profound regret that the current regulatory system was incapable of producing “fitting sanctions” of a nature that “might serve as a suitable deterrent for the next crisis”.

All of which came as sober reading on Friday for David Drummond, who worked for Bank of Scotland for 25 years before being made redundant at the age of 45 as a result of the bank’s woes, then lost the £150,000 life savings he had invested in the bank’s shares. Customers were not the only victims.

Although Drummond welcomed the report’s findings, he said it did not go far enough in addressing the underlying attitudes and culture at the root of the banking crisis.

He said: “I and many of my colleagues who spent their working careers at Bank of Scotland, and who were all very responsible people, trusted that we were putting all our savings in a safe place.

“But HBOS managers betrayed our trust by putting their own self-benefit before that of those they were supposed to be looking out for: customers, shareholders and staff. As a result, we’ve all lost faith in banking management.”

The Commission recommended that Crosby, Hornby and Stevenson should never be allowed to work in the financial sector again but, with the exception of Crosby, it was a case of locking the stable door after the horse had long bolted.

On Friday, Crosby, like the former Sir Fred Goodwin, the once all-powerful chief executive of RBS, knighted for his services to banking, stepped down from a lucrative City consultancy as his act of contrition.

It has largely been left to Goodwin’s successor at RBS, Stephen Hester, to act as the industry’s main reformer of the bonus-driven culture that, even now, shows little sign of being abandoned. Speaking in February, when bailed-out RBS posted a year-end loss of £5.2 billion, Hester outlined the shortcomings that led to the group’s downfall.

“Too often, the banking industry saw its purpose as making money out of customers,” he said. “Of course, we need to make money, but that should be as a result of serving customers well, and we need to do that more of the time.

“Banking arguably spent too much time thinking of itself, its own people, its own interests, and the outside world was a means to that end. If we can turn that process on its head… then I think we will have made a mental transition.”

The malaise appears to cross the banking sector. Findings released on Wednesday from a report commissioned by Barclays in the wake of the Libor-rigging scandal – Libor is the London interbank lending rate which influences interest rates in general – found that sky-high pay had distorted attitudes among bankers who became “oblivious” to reality. Sharp practices adopted to meet the pressure to perform created a “win at all costs” culture. The findings were a searing indictment of the regime of former chief executive Bob Diamond, the investment banker who built the group into a global force but who was eventually forced to resign after Barclays accepted a £290 million fine for its role in the Libor affair.

Like Hester, Diamond’s successor Antony Jenkins, appears to accept that cultural change is necessary if banks are to regain public trust. In a memo sent in January to 140,000 employees worldwide, Jenkins said that performance would be judged on a set of ethical standards with a new code of conduct focused on five values: respect; integrity; service; excellence; and stewardship. Jenkins said: “Performance assessment will be based not just on what we deliver but on how we deliver it.

“We must never again be in a position of rewarding people for making the bank money in a way which is unethical or inconsistent with our values.”

In response to public concern that the financial industry is painfully slow to change its ways, the coalition government is making progress with its Banking Reform Bill. In February, Chancellor George Osborne announced several reforms which he believes will prevent the taxpayer ever being liable again for future bail-outs if banks fail.

In future, UK banks may be required to separate everyday banking activities from the riskier and more volatile aspects of banking by having a ring-fence around the deposits of individuals and businesses. The UK government also wants to enforce the new Prudential Regulation Authority (PRA) – a subsidiary of the Bank of England – to be able to split banks up if they flaunt the new rules.

The bill will also give the government more power to ensure that the banks are able to absorb more losses than previously; the banking industry will also be expected to foot the bill, rather than the taxpayer, of meeting the Treasury’s costs of working within the new parts of the international regulatory architecture.

At the time, the chancellor said: “Our principles are simple: if you do the right thing, government should support and help you, and remove the barriers in your way. If you do the wrong thing, you should take responsibility for your actions. And sadly, nowhere have these simple principles been broken more clearly and indefensibly than in our banking system over the last decade.”

Official action on bonus culture, however, is likely to be left to the European Union, where legislators are planning to bar bankers throughout the continent from getting bonuses bigger than their salaries.

Even that measure – opposed by Osborne because of fears banking talent will desert the City of London – is unlikely to be in place until the middle of 2014 at the earliest to allow countries time to complete legal preparations, and sparing bankers at least one more bonus season.

Sharon Bowles, the Liberal Democrat chairwoman of the European Parliament’s economic and monetary affairs committee, spoke for many when she said that concern about a banking talent flight was exaggerated. “The mass exodus from the City of London by disgruntled bankers demanding the astronomical bonuses of yesterday remains to be seen and I am sure fair-mindedness will prevail,” she said. “The bankers’ bonus cap will usher in a much-needed culture change, not just for the City of London, but for the rest of Europe too.”

Spicer, of the Cass Business School, agrees. He said: “What could be the difference in this case is that it is not just one organisation going through a cultural change, but an entire industry going through that structural shift.”

Liberal Democrat MP John Thurso, a member of the parliamentary commission on banking standards that delivered Friday’s damning report on HBOS, is among those who believe a longed-for cultural shift is taking root within the industry. He estimates that about half of the work has already been completed, with a further 30 per cent likely to be implemented within the next two to three years. The remainder, however, will likely take a decade to work its way through.

“We have already done an awful lot that is making a significant difference almost straight away,” Thurso said, referring to tighter regulation, more stringent capital rules and a growing acceptance that outlandish pay packets are unacceptable. “On the culture side, what we are now trying to do is the much more difficult bit, which is to look at the character and culture in banking. That is a much tougher task, but it can be achieved with time.”

Twitter: @KristyDorsey