Banks – Why do they do it?
Like Richmal Crompton’s William Brown, the banks seem for ever to be getting into scrapes. The regulator has spoken of their “culture” as being the source of so many of their difficulties with the regulators, the press and the public. I agree.
My contact with the very top levels of the banks is limited. I have acted for some very large building societies and I have also acted for a director of a major high street bank, but in the main I do not mix in top banking circles. So I have nothing to say about management at the very top save that the building societies I dealt with were run with integrity by principled people.
I do however see quite a lot of the work undertaken by financial advisers and others employed at the retail branch level by the major banks. I have also dealt with a lot of independent financial advisers who worked at an earlier stage in their careers for banks and life insurance companies.
The core difficulty is that banking, a perfectly respectable profession in itself, involves treating the customer as the person you are doing business with. Whatever transaction it is recommending, the bank is frequently one party and its customer another. It is perfectly natural, indeed essential, to a banker to be able to undertake transactions with a customer that yield the bank profit.
The professional adviser, however, like a solicitor or accountant or (these days) an independent financial adviser has an obligation of good faith – what the lawyers call a fiduciary obligation. That obligation involves total loyalty to the customer and precludes trading with a customer at a profit, and certainly not at an undisclosed profit. When the banks and life insurance companies went into financial advice a collision between these two principles was inevitable.
The battleground has been centred around the banking regulator (now the Financial Conduct Authority). This is tasked with implementing European law directives. The current EU directive in relation to financial advice is Directive 2004/39/EC, called the Markets in Financial Instruments Directive or MiFID for short. That makes it plain that conflicts of interest are to be avoided. Article 19 says “Member states shall require that, when providing investment services and/or where appropriate ancillary service of clients, an investment firm acts honestly, fairly, and professionally in accordance with the best interests of its clients and complies, in particular, with the principles set out in paragraphs 2 to 8“.
A bank, no more than any other kind of tradesman, cannot really treat its customers in that way. Its business model requires that its staff act in the best interests of the bank, not the customer.
The rules prescribed by the FCA and the various banks’ compliance departments are labyrinthine and there is no need to explore their complexity here. The essence is that the clash between cultures is at the root of the difficulty with retail advice by banks to their customers.
This conflict has long since been resolved by the IFAs. IFAs used to be commission-driven, high street traders. Now they have moved upmarket and are much more professional. The banks have yet to make the same move and in this respect have fallen behind. Thus it is that perfectly respectable, honourable, loyal employees of the banks find themselves accused of profiteering at the expense of those whom they are paid to advise. The tabloids would characterise them as the spawn of the devil; but they are not, they are decent folk but badly led.
This dilemma is slowly being played out in the courts. There have been a number of high profile mega rich claimants who have sued banks and failed, in essence because they claimed to be innocents when they were not. However, we are now entering into a spate of claims by small businesses who are claiming damages for mis-sold interest rate swaps. I write about these elsewhere on this site, but they are in essence bets against the bank on movements in interest rates. This is a classic conflict situation. One day one of these (or a similar case) will result in a judgment clarifying the duty to avoid conflicts, and the financial world will be a lot healthier as a result.