Thursday, 26 November 2009

Banking Governance

Kudos to Sir David Walker who has at least understood some of the big issues in the banking sector and has proposed some major changes which he believes the UK should lead on.

However, I still do not think anyone has nailed the crux of the problem. It's all very well proposing that banks should disclose how many people earn of £1m or more and that Non Execs (NXDs)and shareholders should take more responsibility in the governance of banks but I really do believe it is naive to believe this will actually solve anything, even if it is a step in the right direction.

Firstly, disclosing millionaire earners is neither here nor there - meaningless in the great scheme of things and it reveals nothing of how a banks works, the basis of reward schemes or whether it is acting properly or not. It is a mere barometer and if anything, it advertises to peer companies which bank is prepared to pay more of its employees more money. As for NXDs and shareholders having more say, I believe there are several issues here.

Firstly, we have seen how NXDs have acted in the lead up and during the crisis. As the proverbial hit the fan and one of its biggest perpetrators was being thrown to the dogs, they still acted as if nothing was wrong in conjuring up a massive pension pay off for Fred Goodwin or re-engaging Andy Hornby on a £60k per month consultancy contract at HBOS. Because the rewards of the NXDs are inextricably linked to the profits, they are hardly likely to kill the golden goose - they are by definition already wealthy people who are there to make a great deal more money. Then there are the shareholders. Of course, their rewards are dependent on the banks' fortunes as well but there is a bigger issue at play.

The vast majority of bank shares are owned by the public but indirectly - either via the Government and its vehicle, UKFI, or via pension funds and the like. The general public owns very few shares individually. Therefore any involvement by shareholders comes as 'block votes' from these 'aggregators'. Again, both fund managers and directors of UKFI are charged with obtaining maximum value from the shareholdings so they are hardly likely to vote against making profits. Again, they are all wealthy individuals and are motivated by making a great deal which their own bonus schemes generously allow.

Finally, as the whole of the banking industry now has a safety net of unlimited lack of liability to their losses should there be wide scale failure, there is zero incentive for any of the 'aggregators' to act in any way different to the banks themselves. Indeed, even the staff at the FSA all received bonuses for last year despite presiding over catastrophic losses.

There are far more fundamental issues to be resolved here and it isn't rocket science. At the heart of the banking system lies a serious flaw and a massive liability. Upon this flaw, the global financial system has built an estimated $550 trillion of open derivative positions and a further $400 trillion of associated insurance positions - all of which are so convoluted as to be virtually unauditable. As long as banks are allowed to continue trading in such products and financial instruments, then the rewards will be massive and yet largely unreal.

Until we get to grips with these 'Financial Weapons of Mass Destruction' as Warren Buffett called them, we will always have a basic issue of governance in banks for which the taxpayer will be liable - yet we are the biggest shareholders.

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