Barclays scandal could trigger real banking reform

As the Barclays and JP Morgan scandals unfurl, calls for stricter regulation and even a wholesale change in banking culture, will only grow.

There comes a time, in banking as in life, when deniability stops being an excuse, even if it’s plausible. So it became for Bob Diamond, the now former CEO of Barclays PLC, in early July.

Diamond resigned after his firm admitted to serially fudging submissions used to calculate the London Interbank Offered Rate (LIBOR), a key interest-rate benchmark of the global financial system. But he did not go quickly or with enthusiasm. Even after the British bank agreed to pay US$451 million in fines for its wrongdoing, and chairman Marcus Agius stepped down, Diamond vowed to stay on the top job. His presence was crucial to the firm’s recovery, he argued. Besides which, he had no direct knowledge of the malfeasance.

Diamond’s defence, brief though it was (he resigned on July 2, two days before he appeared before a committee of Britain’s Parliament), was remarkably similar to that of his American counterpart Jamie Dimon. The combative JPMorgan Chase CEO was still dodging calls for his own head when Canadian Business went to press, more than a month after he admitted that a trader in the firm’s London office lost at least US$2 billion, and possibly as much as US$9 billion, in a deal gone wrong.

Throughout their ordeals, Diamond and Dimon clung to what has become the company line in banking scandals: the damage was contained, senior management didn’t know about it and, most important, it wasn’t systemic. Problems, in other words, were not with the banking industry, its culture, or regulation, but with a few isolated bankers.

But there are growing signs that line is wearing thin. Even among audiences traditionally sympathetic to the big banks, there is more and more a sense that something is deeply wrong in global banking, something that cannot be settled by the institutions themselves.

On July 3, for the first time, the traditionally conservative Financial Times newspaper endorsed the total separation of investment and retail banking in Britain. In an unsigned editorial, the editors argued that the investment ethos has poisoned that of the traditionally more cautious retail set.

Others are calling for smaller, if still significant, change. In a note sent to clients in July, Bob Eisenbeis, chief monetary economist at Cumberland Advisors, suggested incentives have become dangerously out of whack for traders. E-mails dug up by investigators in the Barclays scandal, he argued, showed a “cowboy mentality at work,” one “driven by short-term profits on trades that were in turn likely influenced by the bonus and compensation schemes in place.”

But for every specific policy change suggested in the wake of the Barclays and JPMorgan affairs, there have been 10 more attacks on the culture and people that allowed them to happen. Those broadsides, it’s worth noting, haven’t always come from traditional bank-bashers or those on the political left. In its first issue after Diamond appeared before Parliament, The Economist referred to the central figures in the LIBOR scandal as “banksters” (as in gangsters) and said they exposed “the rotten heart of finance.” In a lead editorial, the magazine called for a “change to the way finance is run—and the culture of banking.”

For the big banks, on the run from even their traditional defenders, things will likely get worse before they get better. The JPMorgan loss was big, but it was contained to a single bank and its shareholders. The LIBOR scandal is on another scale entirely. More than US$500 trillion worth of contracts—everything from swaps and futures contracts, to home mortgages and student loans—were priced using LIBOR rates last year. Barclays was merely the first to settle charges it fiddled with the benchmark for its own gain. It will almost certainly not be the last. At least 10 other banks are under investigation in at least half a dozen countries (including Canada) for pulling similar schemes. Regulators, too, may well be drawn in. Barclays has released information suggesting Diamond was given at least a tacit green light to fix rates during the heart of the financial crisis by Paul Tucker, deputy governor of the Bank of England. The bank also claims it raised concerns about LIBOR fixing by other institutions as far back as 2007, to no avail.

Regardless, as more charges are settled and new ones laid, calls for stricter regulation, or a wholesale change in banking culture, will only grow. “This incident does reinforce those who say we need to get finance working for the real economy, not the real economy working for finance,” says Jim Baker, the director of the Global Economy Program at the Centre for International Governance Innovation in Waterloo, Ont. “I think there is a very strong argument for that.”