Questions are asked of Rot in Banking Culture

Peter Eavis. March 13, 2014. New York Times.

Money laundering, market rigging, tax dodging, selling faulty financial products, trampling homeowner rights and rampant risk-taking — these are some of the sins that big banks have committed in recent years.

Now, some government authorities are publicly questioning whether such misdeeds are not just the work of a few bad actors, but rather a flaw that runs through the fabric of the banking industry. After years of saying little about the behavior of bankers, even as one scandal followed another, regulators are starting to ask: Is there something rotten in bank culture?

At the heart of the issue is an inviolate social contract that bankers are supposed to honor. The government agrees to protect banks from collapse, and in return, bankers are meant to uphold the highest ethics when handling other people’s money.

But when lawbreaking and other missteps proliferate at banks, it is a sign that the industry has stopped cleaving to the special contract, endangering taxpayers. And bad management can be a leading indicator of future financial problems at an institution. “It usually translates into losses down the road,” Mr. Curry said.

It is a concern recently voiced by William C. Dudley, president of the Federal Reserve Bank of New York, the institution that has more day-to-day contact with Wall Street than any other arm of the government.  “There is evidence of deep-seated cultural and ethical failures at many large financial institutions,” Mr. Dudley said in a speech that sent a chill through the financial industry last year.

In a recent interview, Mr. Dudley explained why he decided to make such a loaded point about bank culture: “To make it clear that ‘too big to fail’ isn’t the only problem,” he said in his office three blocks from the actual Wall Street in Lower Manhattan. “I don’t want senior bank management to feel, ‘Oh gee, if we solve “too big to fail,” we’re done.’ ”

“Too big to fail” refers to the belief that some banks are so large that if they got into trouble, the government would have to rescue them to prevent their failure from harming the wider economy. Congress and government authorities have taken many steps to put banks on a firmer financial footing, but such efforts do not focus on cleaning up the ethics of large companies.

Other senior regulators are speaking out in a similar vein. Thomas J. Curry, the head of the Office of the Comptroller of the Currency, has recently devoted several speeches to cleaning up the culture of banks. In a recent interview, he gave some insight into how his agency sometimes views its relationship with the banks.

The big question is whether regulators have the resolve to back up their tough words with meaningful punishments. Banks, for instance, have armies of lawyers who deploy strategies like refusing to turn over potential evidence to regulators. And the largest banks make such big profits these days that they can easily absorb the financial penalties the government throws at them. Also, notably, top bank executives did not voice their support for Mr. Dudley after he gave his sharply worded speech on culture.

But boards may have very different priorities from regulators. Directors may not see the need for far-reaching changes if a bank is producing large profits that benefit shareholders.

JPMorgan Chase’s board took steps to hold management accountable after the so-called London Whale trading scandal that engulfed the bank in 2012 and 2013. Still, in January, JPMorgan’s board approved a large raise in the 2013 pay of Jamie Dimon, the bank’s chief executive.

And compensation is one area where bank regulators may need to do more if they want to do more to clean up bank culture, according to critics of the industry.

Wall Street’s compensation practices can reward unhealthy levels of short-term risk-taking and entice bankers into ethical lapses. Acknowledging that, regulators around the world agreed after the crisis to overhaul bankers’ pay, in part by requiring them to wait several years before they receive all of their bonuses. The hope is that bankers will behave better if they know their employers can easily take back the deferred part of their pay.

But there is evidence that large American banks are still deferring much less pay than their European peers. The Fed is in charge of regulating compensation at American banks. When asked whether the pay overhaul at American banks had gone far enough, Mr. Dudley said, “There is potential to defer more compensation for longer periods of time.”

One particularly daunting challenge looms over the efforts to improve the ethics of banks. Some banks may be so large and complex that it would be difficult for managers to maintain a clean culture across all of their operations.