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Clean up and mutualise banking

Prem Sikka argues serial corruption within banks requires urgent democratic solutions.

Banks have been serial offenders for a long time and the culture of abuse can't be arrested by markets or shareholders.

A 330-page report by the US Senate Permanent Subcommittee on Investigations reported that due to poor controls HSBC facilitated money laundering for shadowy organisations and individuals from Mexico, Iran, the Cayman Islands, Saudi Arabia and Syria. HSBC is expecting a US fine of hundreds of millions of dollars. Bank of America is also on the radar of the US authorities for alleged money laundering.

Coutts, the bank used by the Queen, has been fined £8.75 million for lapses in complying with money laundering regulations. In June 2012, a former Board member of Goldman Sachs was convicted of sharing insider information with a hedge fund friend. In February 2012, a former managing director of Merrill Lynch International (now Bank of America Merrill Lynch International) was fined £350,000 for engaging in market abuse by improperly disclosing inside information ahead of a significant equity fundraising by a client company.

In late July the UK's Financial Services Authority (FSA) announced a probe into whether Barclays Bank comprehensively disclosed the fees that it paid to its advisers in connection with £5 billion raised from Middle Eastern investors in 2008. In June Barclays was fined £59.5 million by the FSA and US$290 million by the US regulators for manipulation of the London Interbank Offered Rate (LIBOR) which made the bank look more credit worthy and also generated huge profits. Other banks are also likely to be in the LIBOR frame.

The above may have shocked some, but seasoned observers know that banks have been serial offenders for a long time. They offer measly returns on savings, but charge huge fees on loans, credit cards and overdrafts. They have a history of mis-selling financial products, such as payment protection insurance (PPI), endowment mortgages, pensions and loans to small/medium businesses. They have been leading players in tax avoidance and often provide orchestrated finance to enable client companies to construct sham transactions which have little economic substance, but result in tax being dodged. They are no strangers to tax avoidance.

In February 2012, the UK government took the unusual step of introducing retrospective legislation to halt two tax schemes that would have enabled Barclays to avoid around £500 million in corporate taxes. The Treasury's press release referred to the schemes as ‘highly abusive … designed to work around legislation that has been introduced in the past to block similar attempts at tax avoidance'. The Royal Bank of Scotland (RBS) bought back its own bonds in the market at a profit of £3.8 billion. The deal was structured in such a way that the bank avoided paying any tax on this transaction. In 2009, it was reported that the bank avoided around £500 million of UK [and US] corporation tax by using large sums of money to create complex international tax-avoidance schemes.

These are just a small sample of the misdemeanours of banks over the last forty years. Fines and penalties have become just another cost of doing business and have done little to curb predatory practices. Costs are passed on to customers and executives walk away with mega bonuses. It is hard of think of any instance when shareholders have curbed rapacious behaviour of banks or their executives. They have always been focused on short-term gains and cared little about the social consequences of the quest for higher returns.

A fundamental change in the way banks are governed, rather than the cosmetic changes contained in the new Banking Bill, is needed. The market pressures for higher profits at almost any cost should be checked by turning all banks, at least the retail side, into mutuals and co-operatives. As some bank executives have become addicted to gambling, the speculative side should be legally separated from the retail side and be subjected to unlimited liability. Let us see how many executives want to gamble with their own money. For the rest, employees, customers and borrowers have a long-term interest in the business of banks and should be empowered to elect and remunerate directors. Directors need to be made personally liable for the cost of knowingly approving predatory practices.

The regulators have been ineffective because they frequently come from the same industry and are too sympathetic to its practices. This should be checked through annual parliamentary hearings. All policy meetings of the banking regulators should be held in the open, and information in the regulator's possession should be made publicly available. Regulators should have permanent strategic presence at all banks so that danger signs can be monitored on a real-time basis.

This should be the beginning of reforms necessary to curb the worst excesses of an industry that has a long record of damaging the lives of millions of innocent people.