Monday, 23 July 2012

Banks: A Loose Federation Of Money Making Franchises

The LIBOR fixing affair continues to throw up new information and insights which are mostly entirely predictable.  Consider two of last week’s front page news stories:

(1)    The FT led with a shock, horror story about collusion in fixing Euribor (the European equivalent of Libor) because a named Barclays trader Philippe Moryoussef  had allegedly organised collusive rate fixing with three other named individuals at Credit Agricole, HSBC and Deutsche. We did not before reading this story know the names involved in this new scandal. But the nature of the LIBOR (and Euribor) reporting process was such that we did already know that any kind of rate fixing must have required collusion between traders at several banks (and such collusion of course must then raise questions about the involvement of middling and senior management).

(2)    The Wall Street Journal led its front page on Wednesday 18th with a political analysis of the Bank of England. Mervyn King had appeared before the Treasury Select Committee and explained that the Bank of England was not suspicious about LIBOR rate fixing because nobody had formally told the Bank: “The first I knew of any alleged wrong doing was when the reports came out two weeks ago….we’ve been through all our records; there is no evidence of wrong doing or reporting of wrong doing to the bank”. This absence of curiosity is entirely predictable. From the Guinness stock manipulation affair in the mid 1980s to LIBOR rate fixing in 2012, wrong doing is uncovered  by American investigators who, in effect, oblige the uncurious Brits to take action.

There is something about the reporting of such news stories which connects one world of behaviour which is very English with another world of judgement which is New York Jewish. Mervyn King’s testimony to the Select Committee brings to mind that refrain from the Paul Simon song: “when something goes wrong, I’m the first to admit it and the last one to know”. Or, as Paul Simon’s psychoanalyst might put it: “how is it possible for these English elite technocrats to be so clever and yet lack all knowledge of self and others?”. And, of course, though the news stories are different each year, there is then nothing really new about that disabling absence of self knowledge and worldly curiosity in English elite figures who, like our prime minister, aspired to the top job because he thought he would be rather good at it.

 But, to be fair, we have learnt something new last week. The learning was about the internal organisation of banks from other witnesses who testified on investment bank rate fixing before the Treasury Committee and on money laundering in a US Senate hearing. We are already indebted here to anthropologists like Joris Luyendijk and Karen Ho who have described the processes of selection and acculturation which produce a dangerously conformist mentality inside banking firms which operate like silos. But last week’s public testimony by senior bankers In London or New York highlights larger questions about how the organisation of giant banks makes them unfit for purpose. Here we are taking up some of the issues which Joris raised some in his blog about out of control banks. 

Let’s begin with some generalities which should be familiar to anyone who has done an introductory course in organisation studies.  A firm is a space of bureaucratic coordination which requires internal hierarchy and division of labour which implies expectations and rules about what can and cannot be done at different levels, and runs partly on active instructions and permissions de haut en bas. Any organisation then requires individual and group initiative because rules and instructions cannot be complete and improvisation is required. But such improvisation operates within procedural limits so that, for example, authorisation of expenditure or breach of standard procedure usually requires some kind of signing off and a paper trail.

All this is a mixed blessing. The firm or any other large organisation is for bureaucratic reasons typically an inflexible, unreflective economic and social actor with a limited capacity to respond to how things have gone wrong or indeed to recognise that things have gone wrong or will go wrong. Think about BP’s succession of accidents and environmental disasters  after the Browne led  mergers had created  a much larger firm where operating control was a major unresolved problem; or, worse still, think about how hierarchy allowed the Catholic Church to cover up child abuse in many jurisdictions.

But the investment bank illustrates two different problems which make investment banks like Barclays or retail banks like HSBC positively frightening, not just poorly controlled like BP or unintentionally collusive like the Catholic Church. On the basis of last week’s testimony in London and New York, the present day investment bank is a thoroughly informal organisation where many things, including gross rule breaking at middling levels, can go on without formal authorisation. The bank actively institutionalises the insouciant lack of concern passively manifest in elite English individuals.

On Monday 16th, Jerry del Missier, the recently departed chief operating officer of Barclays appeared before the Treasury Select Committee and gave an account of how Barclays came to ‘lowball’ its Libor submissions in the aftermath of the phone call of 29th October between Paul Tucker of the Bank and Bob Diamond at Barclays, which led Diamond to produce an email note. There was, to put it neutrally, a misunderstanding at this point about whether the Bank was instructing Barclays to lowball (because of the public interest in making Barclays look sounder than it was).

The interesting point is that, along the internal chain of command at Barclays, all the instructions were verbal, even though the instruction was for Barclays to do something irregular at the (second hand reported) invitation of the Bank of England.

The internal chain in Barclays ran from Diamond to Jerry del Missier as co-head of investment banking to Mark Dearlove as head of the money market desk. “ Yes it was” an instruction said del Messier in last week’s testimony when he claimed he had “passed on the instruction as I received it” And how did Del Messier receive it? The FT reported:   “in a phone conversation the day before he received the email note” from Diamond which did no more than report another phone conversation with Tucker.

Let’s pause here. Barclays is clearly not an organisation of the staid, formal kind which most academics will be familiar with.  Let us hypothetically suppose the nearly unthinkable. Some senior authority outside our University (for whatever reason) wants to adjust the academic grades on our degree programmes.  That would require written orders down the chain, then a series of committee meetings so that all those affected could discuss any concerns about issues of authority and implementation. And the committee chairs would be expected to have a written instruction from an external point of origin after, for example, the university’s academic registrar had forwarded an outsider’s direct and explicit email instruction to fix the grades (rather than the registrar’s recall of a phone call).

The investment banker’s counter argument is that such formal bureaucratic safeguards are quaintly inappropriate in the fast moving world of banking: “just do it” because there is no time for all this procedural stuff which still regrettably clutters up the hierarchical public sector. But that raises a serious question. What protects economy and society if the investment bank (as organisation) does without the bureaucratic safeguards which in other cases protect us from compounded misunderstandings and active malpractice? Because, in this world of informality, junior bankers at desks will simply follow verbal orders from their team leaders and their seniors may have a very limited knowledge of what is informally going on at the lower levels.

The social protection is supposed to be supplied internally by a bank’s internal compliance department which enforces standards and polices wrong doing. But, the ineffectiveness of such arrangements were dramatized on Tuesday last week when senior HSBC executives appeared before a US senate hearing to explain how and why HSBC had, despite repeated  US regulatory censure and internal whistle blowing, continued to allow drug proceeds from Mexico to be laundered through the bank and allowed terrorist financiers to obtain US dollars.

David Bagley, HSBC’s chief compliance officer since 2002, admitted to the US Senate that his position lacked any power. As the FT reported, on his own testimony, David Bagley did not control compliance in national affiliates like Mexico because his job was only “to set policy and to escalate issues that were reported to him”. This was front page news partly because of Bagley’s tactical resignation from the job on the day he testified.

But, the largely unreported parallel Senate testimony of Paul Thurston, HSBC chief executive for retail banking and wealth management, was even more devastating; not least because it described an absence of control and rules in retail banking where customers and regulators would quite reasonably expect them. The key exchange was with Senator Levin:

Sen. Levin:  Why did these things fester for so many years at this bank [HSBC Mexico]? This isn’t something discovered in hindsight, this is something that people knew was going on at that bank. Why was it allowed to continue?

Thurston:  The business model was complicated and decentralized. It was very difficult for the center to get controls.

The difficulty of central control was separately explained by Thurston:  

“It became apparent that decision-making process concerning Anti Money Laundering were not satisfactory [at HSBC Mexico]. Over time, it also became clear that this was not only a question of process and technology, but that the underlying business model needed to be examined. Branch managers operated as local franchise owners, with considerable autonomy and a focus on business development, reinforced by an incentive compensation scheme which rewarded new accounts and growth, not quality controls.  

Banks and banking are defined in most dictionaries in terms of business conducted and services offered. In organisational terms, after last week’s testimony, it might be fairer to describe a bank as a loose federation of money making franchises (with always troubling and sometimes dire economic and social consequences).

Dyfal Donc