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The unacceptable face of banking

Financial Events
By Paul Hodges on 03-Jul-2012

Dimon, Diamond.pngBanks are essential in any modern society. Their role is two-fold:

• To take in deposits from companies and individuals
• To lend out this money prudently to other companies and individuals

Both are difficult roles to fulfil. Banking therefore requires employees who have both talent and integrity. They must be able to look after people’s money safely, and they must have the ability to manage financial risk.

Most bankers conscientiously aim to fulfil these challenging roles. But the examples of JP Morgan and Barclays highlight how the top leadership of many banks now appears to have a completely different agenda.

CEO Jamie Dimon apparently either never knew that one of his key units was taking vast trading bets, or he didn’t care to ask. He even denied the first rumours of major trading losses, when the story began to emerge in the financial press, calling them ‘a storm in a teacup’.

Today, the size of the eventual losses is still not known. But they are now expected to be at least $5bn.

CEO Bob Diamond is the head of a bank that has paid a $450m fine for systematically abusing the process by which LIBOR (London InterBank Offered Rate) was set over many years. This is no small issue.

The LIBOR rate is used to price an estimated $350tn of derivatives. Lenders and borrowers all over the world have potentially been affected.

Astonishingly, both Dimon and Diamond are still in their jobs today. No executve director of either bank has taken responsibility for these scandals and resigned*. This single fact shows the depths of the problem at the top of many banks.

The root cause of this problem was Congress’ 1999 repeal of the Depression era Glass-Steagall Act, which separated commercial and investment banking. Top bank executives abandoned their role as prudent lenders. Instead, they focused on increasing their profits as fast as possible via the use of maximum leverage.

In the process, as we argue in chapter 12 of Boom, Gloom and the New Normal, they encouraged the short-termism that has destroyed many companies. One casualty was the blog’s own former employer, ICI – once the largest chemical company in the world.

As the Financial Times notes:

If, as now seems likely, many banks were involved in fiddling rates, this raises questions not just about the leadership of one bank but that of the whole industry. For there to be a real change of heart and expectation, it may therefore be necessary to retire this generation of flawed leaders. This newspaper does not endorse banker-bashing for its own sake. But if the bashing is to stop, the banks themselves must change.

* The only resignation so far is of 65 year-old Marcus Agius, Barclays’ non-executive chairman. He had been chairman since January 2007, and was presumably coming up to retirement shortly.