Short-changing by international banks: Lessons for the banking fraternity and regulators

Settlements and penalties of the last year have a lesson for every international bank, whether big or small, as they provide a peep into the alacrity of crimes committed by the white collar banking fraternity, predominantly in the developed world

The just concluded 2012 can be remembered as the year of banking ignominy, as a number of big international banks were involved in scandals that were beyond easy comprehension. The sheer magnitude of the penalties imposed on them by different regulators was an eye-opener for all the banks in the world. Here is a short synopsis of the major banks involved and their alleged complicity in the art of short-changing the investors and or the State, leading to their prosecution and penalty or settlement. Most of the settlements arrived at were without accepting guilt, but were agreed to with a view to stop further prosecution and investigations. But these settlements and penalties have a lesson for every international bank, whether big or small, as they provide a peep into the alacrity of crimes committed by the white collar banking fraternity, predominantly in the developed world.

Settlements agreed to and penalties levied on banks in the western world:

1. In September 2012, Bank of America agreed to pay investors a whopping $2.43 billion (equivalent of nearly Rs13,000 crore)  to settle claims from shareholders led by pension funds, who had accused it of providing misleading information about the health of Merrill Lynch, which it bought just before the 2008 financial crisis. Besides, Bank of America also paid $150 million (about Rs800 crore) to the Securities and Exchange Commission to settle a lawsuit brought against it in relation to suppression of information about big bonus payments agreed by Merrill Lynch before the merger.

2. In December 2012, Hongkong and Shanghai Banking Corporation (HSBC) agreed to pay a total of $1.9 billion (over Rs10,000 crore) to various US authorities to settle investigations into violation of US anti money-laundering regulations. The bank was alleged to have got involved in illegal transfer of billions of dollars from Iran and Mexican drug cartels to the United States.

3. The Swiss banking giant, Union Bank of Switzerland (UBS) agreed to pay a total of $1.5 billion (over Rs8,000 crore) in fines to various authorities in the US, UK and Switzerland to settle charges of manipulating London Inter-Bank Offered Rate (LIBOR) , the global benchmark interest rates over the period between 2005 and 2010. UBS had said that it would pay $1.2 billion to the US Department of Justice and the Commodity Futures Trading Commission of the US, 160 million pounds to the Financial Services Authority of the UK and 59 million Swiss francs to the Swiss Financial Market Supervisory Authority, (FINMA). This is the second bank; afterBarclays, to be charged with rigging LIBOR and investigations are still on to identify more banks involved in this scandal.

4. The Standard Chartered Bank Plc of the UK had to cough up a total penalty of $667 million (about Rs3,600 crore) in investigations by two different authorities in the US during 2012. This British bank had in August 2012 agreed to pay $340 million fine to the New York Department of Financial Services over Iranian sanctions, when the New York banking superintendent had termed this bank as a “rogue institution” that had shown contempt for banking regulations, leaving the United States vulnerable to terrorists, weapons dealers and corrupt regimes.

Again in December 2012, Standard Chartered Bank agreed to pay a fine of $327 million to the US Department of Justice to resolve allegations that it violated US sanctions against Iran, Sudan and two other countries and moved millions of dollars through the US banking system on behalf of customers in the four sanctioned countries.

5. In June 2012, ING Bank of the Netherlands agreed to pay a penalty of $619 million (over Rs3,400 crore) as per the settlement arrived at with the New York Department of Justice for allegedly falsifying the records of New York financial institutions and moving large amount of funds from Cuban and Iranian clients through New York banks, which violated economic sanctions. The US government through sanctions prohibits certain countries and entities from accessing US banking system as a safeguard against terrorist and money laundering activities, and banks violating these crucial regulations are penalized for such illegal actions.

6. In August 2012, Citigroup entered into a $590 million (about Rs 3,250 crore) settlement with shareholders in a class-action law suit that accused the bank of suppressing vital information about its dealings in toxic derivative instruments before the sub-prime crisis of 2008. Though the bank denied any wrongdoing, it said that it agreed to the settlement to avoid uncertainty in continuing with the litigation, which may be dragged on for a long time. Citibank was one of the banks bailed out by the US government at the height of the financial crisis that hit American banks and financial institutions in 2008.

7. In June 2012, Barclays Bank Plc, one of the largest banks in the UK agreed to pay a penalty of $453 million (about Rs2,500 crore) to US and UK authorities to settle allegations of rigging while fixing LIBOR, the benchmark interest rate, that caused political storm in the UK. This scandal, which cost Barclay’s CEO his job, resulted in sweeping changes in the way in which Libor is set, as LIBOR benchmark rates are used for trillion of dollars worth of loans around the world.

8. In November 2012, JP Morgan Chase & Co agreed to pay$296.9 million (about Rs1,600 crore) to settle US civil charges of misleading investors in the sale of mortgage bonds before the financial crisis of 2008. As per the Reuters report, the Securities Exchange Commission (SEC) had accused JP Morgan of materially overstating in a prospects the quality of home loans that backed a $1.8 billion residential mortgage backed securities offering that it underwrote in December 2006.

9. In similar case, along with JP Morgan, Credit Suisse, a Swiss bank, also agreed to pay$120 million (about Rs650 crore) to settle  with the Securities Exchange Commission (SEC) for the alleged negligence in the packaging and sale of risky mortgage backed securities. As per the SEC statement, the Swiss bank also misled investors by falsely claiming when it would buy back mortgage loans in two offerings in which borrowers had defaulted on their initial payments, and that “all first payment default risk” had been removed.

What does this teach the banks and regulators in India?

The first and the foremost lesson to be learnt from these episodes is that Indian banks operating in different geographies outside India should not only comply with the regulations of the home country, but also scrupulously follow and comply with the rules and regulations of the host country, where they operate, in order to ensure that they are within the ambit of laws in both the countries.

The second important step every bank operating outside India should take is to ensure that they have put in place measures to protect the banks from the reputation risks. Any laxity in safeguarding the banks’ reputation under such adverse circumstances may result in winding up the operations to the detriment of the bank’s image.  Banks all over the world function only with the trust and confidence of the depositors.

Thirdly, the Reserve Bank of India (RBI) too should play a very active role in closely monitoring the functioning of our banks outside India too. It is equally responsible for the orderly functioning of banks, both within the country and outside, so far as Indian banks are concerned.  Simply getting a certificate of compliance from the CEO of the foreign branch, as is done by some banks now, is not adequate in the face of the aggressive stance taken by the regulators in western countries. The RBI should, in its own enlightened self interest, call for a certificate of compliance of all local regulations from independent auditors in respective countries, who should be held accountable, if they fail to bring out any lacunae in the functioning of the banks concerned.

At present, a number of public and private sector banks are vying with each other to get a license from the RBI to open branches abroad. The RBI should not only be discreet and selective in its approach, but also ensure that only banks with high capital adequacy ratio and with strong and effective risk management techniques are considered for such branch expansion, to jealously guard the interest of not only the banks concerned but also the fair name of RBI, as a large number of banks are owned by the central government in our country.

As it is said, “ignorance of law is no excuse”, the RBI should ruthlessly enforce statutory and legal compliance both in domestic and overseas operations of every Indian bank and all domestic operations of foreign banks operating in India without fear or favour.

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 (The author is a banking professional and writes for Moneylife under the pen-name ‘Gurpur)

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