Hefty fines have been imposed over the financial malpractice that caused the global crash, but many fear the punishment has had little impact on banking culture

The clean-up is continuing after the sub-prime mortgage crisis in the US, which triggered a broader banking crisis in North America and Europe, and subsequent government debt crises and austerity drives.

Lenders that packaged up dubious mortgages and sold them to investors are being thoroughly spanked. In the US, hefty fines have been the regulators' favourite tool. Worldwide, in 2012 and 2013, banks paid a massive $138bn in fines and penalties, largely related to mortgage malpractice, according to The Banker magazine.

The latest example is a fine of $7bn levied on Citigroup by the US government. US Attorney General Eric Holder said the bank had “admitted to its misdeeds in great detail”. These included knowingly selling to investors problematic packages of sub-prime mortgages – a practice that was encouraged by the huge commissions traders could make on the sales.

Richard Hopkin, managing director of the securitisation division for the Association for Financial Markets in Europe (AFME), says that one factor in the US sub-prime debacle was an “originate to distribute” model in which US businesses created and packaged up mortgages, sold them, and then washed their hands of them. “The person creating the mortgage had no interest in the long-term performance of the mortgage,” he says. In Europe, “that wasn't an issue”: mortgage lending was already regulated and banks retained more of the risk of a mortgage going bad.

Regulators have sprung into action to close loopholes that would allow such practices. In the US, a general overhaul of the industry, the Dodd–Frank Wall Street Reform and Consumer Protection Act, was adopted in 2010. Among its many provisions, Dodd-Frank includes a risk-retention rule requiring originators of packaged-up mortgages to hold onto at least 5% of the credit risk – one example of a measure to close a gap where bad practice could flourish.

Banks also have moved to strengthen internal controls, wary of the risks to their bottom lines and their reputations. According to the latest Deloitte Global risk management survey of the financial sector (August 2013), financial institutions are being more diligent. Senior management is more involved in checking for potential blind spots where fraud or malpractice could occur – about 90% of financial institutions now have a chief risk officer, compared with 73% in 2008.

Enough already?

So is it enough? Are big fines, regulatory changes and better internal practices enough to save banks from themselves, and the wider economy from another crisis?

Sony Kapoor, managing director of Re-Define, a finance and economics thinktank, says not. Fines “end up being paid not by the people that committed the offences, but by the general group of shareholders”. Many managers got off “scot free” and “for them the party continues more or less unabated”, he says.

Information from the Deloitte survey raises questions about how deep internal changes in banks to prevent bad practice have been. It finds that in only 49% of financial organisations do directors review bankers' bonuses to “consider the alignment of risks with rewards” and to ensure that excessive risk-taking is not encouraged. A fundamental problem of oversize rewards remains. “The incentive will continue to be to bend the rules to maximise short-term gains,” Kapoor says.

On regulation, AFME's Hopkin says there has been “a pretty severe regulatory response,” with a flurry of new rules in Europe and the US. But banks seem to be taking this – and massive fines – in their stride. JPMorgan, for example, was hit with a huge $23bn in fines in 2013, and as a consequence made a quarterly loss. But its 2013 profit overall was $18bn. Profits for US banks in total climbed to a record $155bn. Banking continues to be an incentive-distortingly profitable business.

bank lenders  banks  mortgage crisis  mortgage fines  mortgages 

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