Posted on

British Banking Reforms Make for Tough Directors

[vc_row][vc_column width=”2/3″][vc_column_text]A friend of mine who heads the compliance department of a multinational bank recently drew my attention to the stupefying impact of the United Kingdom’s Financial Services (Banking Reform) Act 2013. Following the impact of the global financial crisis in 2007-2008, in June 2010 the United Kingdom government established the Independent Commission on Banking to inquire into the structural and related non-structural reforms to the UK banking sector to promote financial stability and competition. After slogging through numerous details and nail biting horror stories from members of the public on the favorite whipping boy of human beings: banks, the Commission made its recommendations in September 2011 which resulted in the Financial Services (Banking Reform) Act being published, debated in the UK Parliament and assented to by December 2012.

The fairly righteous indignation of the British public and their parliamentary representatives against “Big Banks” provided the much needed wind assistance for the speedy conclusion of the inquiry and the conversion of their recommendations into law within 15 months. A key outcome of the Act was the creation of a new regulatory framework for financial services which including the abolishment of the Financial Services Authority and creation of the Financial Conduct Authority (FCA).

Please note the nomenclature used in the new entity: “Conduct”. The global financial crisis and the Libor crisis in the United Kingdom a few years later were primarily the result of misconduct on the part of errant bankers. Conduct has become the catchall phrase for addressing the shortcomings and trying to fundamentally shift behavior within the banking fraternity. According to Wikipedia, the FCA mandate includes the power to regulate conduct related to the marketing of financial products and it is able to specify the minimum standards and to place requirements on products. The FCA has the power to investigate organizations and individuals as well as the power to instruct firms to immediately retract or modify promotions that it finds to be misleading and to publish such decisions.

But this is the point that has made many senior bankers as well as banking executive and non-executive directors sit up and take notice. One key objective of the FCA is protect consumers and while the caveat emptor (buyer beware) principle that consumers are responsible for their decisions is maintained, if the consumer’s decision is made as the result of advice then the advisor should be responsible. So in March 2016, a new accountability regime was established called the “Senior Managers Regime” for both the banking and insurance industries. According to the press release on the FCA website, the new regimes will hold individuals working at all levels within relevant firms to appropriate standards of conduct and ensure that senior managers are held to account for misconduct that falls within their area of responsibility.” The thought process behind this regime change is that while there have been numerous occasions of banks being found guilty of flouting conduct rules, there have been very few cases of individuals being held to account.

According to a Deloitte UK publication explaining the Senior Manager Regime, “As there has previously been no requirement to determine who is responsible for what in a bank, it has been possible for individuals to claim that it was someone else’s responsibility, or ‘individuals seeking to protect themselves on a ‘Murder on the Orient Express” defense (It wasn’t me it could have been anyone)’ as noted by Martin Wheatly the former CEO of the FCA.”

Now if I were a senior manager at a UK bank, this is right about the time I would be having a candid chat with my line manager about decisions within my pay grade, with the option of a downgrade in title, but not salary being a viable option. Because the thrust of the new senior manager regime is one: ‘You can delegate tasks but you can’t delegate responsibility.’ The FCA then puts its mouth where its money is and proceeds to produce a lengthy document subjecting its own organogram from the board of directors through to management to demonstrate who has senior management responsibilities as well as prescribed responsibilities and overall responsibilities. The aim of this diagrammatic self exposure is to establish to the public how it expects financial institutions to identify who a senior manager is and where the overall responsibility of their decision flows up the organization’s chart all the way to the chairperson of the board.

It’s a very complicated way to arrive at the conclusion that the buck stops at the chairperson of the financial institution’s board, as one key responsibility that he has been given is quite simply put: “The responsibility for the allocation of all prescribed responsibilities.” In other words: The Big Dog, The Big Cahuna, or He-Who-Shall-Never-Sleep-Well-At-Night.

But all is not lost for chairpersons of financial institutions. The new regime now clearly identifies each senior manager and the scope of his or her responsibilities. In the event of a breach, it’s easy to have that most unfortunate conversation: “One of us has to take one for the team, and it’s certainly not me.” Or in relationship speak: “It’s not me, it’s you who is the problem.” As the Deloitte paper aptly puts it, the increased focus on individual accountability removes the regulators away from the time consuming task of having to determine who is accountable for what, to a position of determining whether the individual(s) responsible took reasonable steps to control their areas effectively and to comply with all relevant regulations.

Given that a large part of our jurisprudence and regulatory frameworks are borrowed from the United Kingdom, it would be interesting to see if this will eventually flow into East Africa in which case bankers should girdle their loins in anticipation.

However, if this regime was in force in the United States, the current refusal of the Wells Fargo CEO John Stumpf to resign for the misconduct of his team in opening fake accounts for purposes of driving up revenues would be difficult to maintain.

[email protected] Twitter:@carolmusyoka[/vc_column_text][/vc_column][vc_column width=”1/3″][/vc_column][/vc_row]

Posted on

Chasing The Truth In Parliament

[vc_row][vc_column width=”2/3″][vc_column_text]Last week, an unlikely source in the form of a Parliamentary Committee helped to unseal the tightly held lips of the Chase Bank’s board of directors. The directors had been summoned to assist the Committee to understand the challenges that faced the Bank, resulting in the same being placed under receivership by the Central Bank of Kenya. This was an opportunity for the board to give its side of a controversial story, a tale that has as many versions as there are heads to the Greek mythical hydra. The story caught my attention for one reason only: The directors called the auditors professionally ignorant. Actually let me quote the exact statement here: “The Musharakah Agreements for each of the SPVs clearly show Chase Bank’s 99% interest in the Musharakah assets. Deloitte’s insistence on treating this as a normal loan or advance can only be labelled as professional ignorance at best.” Part of the dispute between the auditors, Deloitte in this case, and the board of directors has been on the treatment of a series of real estate transactions either as internal loans to a key shareholder (according to the auditor) or as Musharakah assets (Islamic financing terms according to the directors). So I pored over the submissions made by the directors in their vigorous defence of these assets.
Banking is premised on the fact that there are depositors who want a safe place to put their money, and there are borrowers who require to borrow funds for consumption. The bank is simply an intermediary. In the case of Islamic banking, the institution applies Sharia compliant procedures in the booking of those deposits and loans. The key point here is: there must be a customer. Period. Finito. Whether it is mainstream or Islamic banking there must be an individual or an entity who is the customer. But the directors state thus in their parliamentary submissions:
“Subsequently, Deloitte rejected the Musharakah Agreements and Deloitte insisted that the Musharakah properties be charged to the bank, thus effectively classifying the SPVs as Loans and Advances rather than Islamic investments as documented. These loans would then become technical insider loans, as the shares in the SPVs were held by the two directors, albeit held in trust for the Bank. Chase Bank’s Management emphasised to Deloitte that treatment of the Musharakah assets as Loans and Advances would be in contravention of not only the principles of Islamic banking (and therefore a breach of trust with Islamic depositors), but also of Section 12(c) of the Banking Act and
would incorrectly treat these as an insider loan. It was evident that Deloitte were simply not interested in appreciating the nature and substance of the Musharakah Assets or the principles of Islamic banking.”

I scratched my head and read the report twice over. At no point did the directors say who the ultimate customer was. I mean, a bank doesn’t wake up and decide to give a loan out to a customer, whether Islamic or otherwise. Why was there no attempt to say that this was an unfair treatment of a yet-to-be-named customer who had borrowed from the bank in good (Islamic) faith? That the assets were bought in the name of the SPV is not in doubt. That the SPV has two Chase directors as the shareholders is not in doubt. But where the shareholders were holding the shares “in trust” for the bank is where it starts to get “grab-a-bag-of-popcorn” interesting. The directors fail to mention if a “deed of trust” was provided to the auditors as evidence of that understanding between Chase Bank on the one hand and the SPV shareholders on the other. I mean, one doesn’t assume trust falls off the back of the Kisumu express train, it must be documented somewhere, right? The directors beat their Islamic financing drum further by dragging in the regulator into their drama: “On 26th July 2012, Chase bank wrote to the Director of Bank Supervision at CBK requesting CBK to revise the Central Bank Prudential Guideline on Publication of Financial Statements and Other Disclosures to accommodate Islamic products and
specifically:
(i) the Islamic Banking Income received to be reflected separately in the Profit and Loss
Account;
(ii) The Islamic Banking Expenses also to be reflected separately in the Profit and Loss
Account;
(iii) The Islamic Banking investments or Financing Activities as a separate Asset line in the
Balance Sheet;
(iv) The Islamic Deposits or Liabilities as a separate Liability item in the balance Sheet; and
(v) A separate Off Balance Sheet line item for Islamic banking.
The CBK has not objected, in the absence of any changes to the Prudential Guidelines, to the classification and treatment in any of its reports to the Bank.”

I have to admit, that this submission by the directors stumped me. If you wrote to the regulator and asked to be reporting Islamic Banking products separately, and the regulator did not object, then why do your 2014 and 2015 financial accounts not reflect the same? I zoomed across to the only fully-fledged Islamic Banks in Kenya, Gulf African Bank and First Community Bank (FCB) websites to see how their Islamic assets are recorded. Their professionally competent auditors in the name of KPMG and PriceWaterhouseCoopers (PWC) respectively reported loans as “financing activities (net)” exactly as Chase had requested the CBK to do in (iii) above. (It’s noteworthy that PWC audited the FCB accounts in 2014 but the 2015 published accounts are silent on who their auditors were) If Chase directors had knowledge as far back as July 2012 on how “Musharakah Assets” should be recorded on the balance sheet why wait until June 2016, or four years later, to call their auditors professionally ignorant? And why are the Islamic depositor funds not separately recorded yet the directors have vigorously highlighted the potential breach of trust for the Islamic depositors if Musharakah Assets are treated as loans and advances?

The Chase Bank saga is a case study of corporate governance failure, weak internal controls, questions on the auditors’ scope and depth of review and a passionate to almost rabid love for the brand by its most loyal customers. But on the back of all of that are innocent depositors who must always remain in the minds of all bank directors whose oversight role gets heavier with each passing day.

[email protected]
Twitter: @carolmusyoka[/vc_column_text][/vc_column][vc_column width=”1/3″][/vc_column][/vc_row]