In September 2007 the UK banking industry began exhibiting
symptoms of the financial crisis that started in America in 2006. Northern Rock
was in trouble and had to ask the Bank of England for help. When news of this
got out customers started queuing around the block to withdraw their money. In
2008 Northern Rock was nationalised, and in 2012 it was bought by Virgin Money.
Today the banking industry can be seen to be on the road to
recovery. But on that road there have been potholes of controversy. I'm
thinking Libor, excessive bonuses, payment protection mis-selling and foreign
exchange manipulation, to name a few.
But before we look at those in a bit more detail, let's
quickly recap on the financial crisis and what it did to UK banking. To do that
we need to start in the States.
In 2006 American banks started seeing a rapid rate of
default against sub-prime mortgages. These mortgages were granted to high risk
customers, many of whom didn't understand what they were getting into, and had
difficulties repaying the loans. The banks must take some responsibility for
their loose lending principles. For instance, they were happy to lend to NINJAs
- customers with No Income, No Job or Assets. And they also offered 'teaser'
type mortgages, with an initially low interest rate that was hiked up sharply a
few months later. With such a rate of default the price of houses dropped
substantially, and your average American became poorer, with many becoming
homeless.
Banks tried to mitigate their risk by selling bundles of
mortgages to secondary buyers such as investment banks. In a process known as
securitization, those secondary buyers might once again re-package the
mortgages and sell them as bonds or as something called a Collateralised
Mortgage Obligation. Essentially investors in these products are being paid
with the interest generated by the underlying mortgages. But as defaults
increased the value of these securities decreased.
Banks tried to cover their risk on these CMO's by buying
insurance against default, using an instrument known as a credit default swap.
The sellers of these swaps then covered themselves against the risk of the swap
they'd just sold by buying yet another credit default swap. It was getting
complex. When mortgage defaults caused a drop in the value of collateralized
mortgage obligations, the credit default swaps had to pay up, and banks started
seeing significant losses. The reduced liquidity led to a freeze in trading of
CMO's, then the banks stopped lending to each other altogether.
Enter Northern Rock, who needed this short term lending to
maintain business as usual. We know what happened to them subsequently. Banks
all over the world were suffering losses by this stage, and headlines were made
when US bank Bear Stearns had to go to the Federal Reserve for funding. They
were taken over by JP Morgan shortly afterwards. Then the floodgates opened,
with the bankruptcy of Lehman Brothers in 2008 prompting a consolidation of
banks (Lloyds bought HBOS, Bank of America bought Merrill Lynch). The whole
financial system was under such a strain at this point that government
intervention was required.
The UK government propped up Lloyds/HBOS and RBS with around
£37 billion of taxpayer's money. Interest rates were cut from 5% in September
2008, and by March 2009 they were at 0.5%.
At the same time guarantees were given to savers that their deposits up
to £50,000 would be covered (now £85,000). In 2009 further government support
was needed, and according to The Independent the bill was up to £850 billion by
December of that year. The Bank of England began its quantitative easing
program in March of 2009 to pump more money into the system, and since 2010
some stability has returned to the banking sector.
Of course businesses suffered from the lack of lending
during the crisis, and ordinary people were affected as a result. The public
trust in banks took a knock, and people were less than pleased that it was
billions of pounds of their taxes that bailed out the 'irresponsible bankers'.
Public perception has continued in a negative vein, fed
initially by the revelation that banks continued to pay exorbitant bonuses on
both sides of the Atlantic during the bailout period. In the U.S. it was
reported that nine banks paid out $32.6 billion in bonuse in 2008, while at the
same time receiving $175 billion in government aid. In the UK around £12
billion was paid in bonuses in 2008. The continuing disquiet about the level of
bonuses paid led to the European Union legislating a cap on bonuses. However,
banks and other financial institutions in the UK have been creative about
getting round the cap, by in some instances increasing share allocations and
raising the basic salary of their top executives.
The mis-selling of payment protection insurance goes back
over ten years. The banks found these a very profitable product as they only
ever paid out on around 15% of policies sold. These policies pay the borrower's
premiums if he/she is ill or loses their job. The complaint against the banks
is that the policies were expensive and often sold as part of the package,
without the customer's knowledge. In 2006 the FSA began imposing fines for
mis-selling, and since then the claims have snowballed. The banks have been
forced to put aside billions of pounds to meet them.
Then in 2012 the Libor scandal hit. Libor is the interbank
lending rate, and was set on a daily basis by a panel of banks in London. It
transpired that some banks were manipulating the rate to gain a trading advantage,
or to give a false impression of creditworthiness. Europe and America were
affected, with various lawsuits being brought in America against banks on the
grounds that mortgage payments were too expensive, or in the case of local
authorities that payments on bonds they had bought were too low. Barclays, to
name just one bank, was fined hundreds of millions of dollars and lost a CEO,
Bob Diamond, as a result of the scandal. After investigations and suggestions
of reform, the Libor rate is now no longer administered by the British Bankers
Association, but by a new independent administrator appointed by the FCA. The
irony is that Libor manipulation probably goes back 20 years and seems to have
been regarded as almost a business as usual activity.
If that wasn't enough, in mid 2013 allegations surfaced of
another manipulation, this time of the daily foreign exchange rates. Forex
traders across several banks were allegedly colluding to set a daily benchmark
rate used by corporate customers. Again, this is something that may have been
going on for ten years or more. As a result the banks concerned are under
investigation and several traders have been suspended. Mark Carney, the
Governor of the Bank of England, told a Treasury Select Committee in March that
the allegations are "as serious as Libor, if not more so".
Just a selection of questionable banking practices then. In
the last five years there were also money laundering offences, credit card
insurance mis-selling, rogue and insider trading - the list goes on. If money
wasn't devalued by inflation I'd just convert all my assets into cash and stick
it under the mattress. Maybe I'll be offered a collateralized mortgage
obligation instead - who could resist?
Darren Winters
