Saturday, August 11, 2012

Barclays, Bob Diamond and Lessons

By Olu Akanmu

Bob Diamond, high profile CEO of Barclays was forced to resign last month over the manipulation by Barclays of the LIBOR. Barclays was fined nearly 300 million pounds by British and American regulators over the corporate sin. LIBOR is the London Interbank Offered Rate. It is fixed each day by an eighteen member selected panel of  banks, members of the British Bankers Association indicating the rate they would have to pay to borrow if they needed money. The top four and the last four estimates are discarded while an average is taken of the rest. The banks are expected to act with trust and transparency recognizing the implicit burden of trust that the public places on their daily estimates because the LIBOR is used as a benchmark for pricing of many financial instruments including savings rate, mortgages, commercial lending and the pricing of financial derivatives. Each bank quote into LIBOR calculation essentially is an estimate of the inherent composite risk of the bank on a daily basis. Given the wide use of LIBOR as a benchmark for the pricing of global financial instruments, it is remarkable that the process is not managed by government or a regulator but privately by the British Bankers Association. Such is the implicit public trust in the process and in the selected bank panel. British regulators uncovered evidences that Barclays traders pushed their money market desk to doctor submissions for LIBOR with the intent of gaming the process and making huge undeserved profits. There were also evidences that they might have colluded with their counterparts in other banks in gaming and manipulating the LIBOR process.
Bob Diamond had arrogantly told the British Parliament January last year, in the heat of the financial derivative crisis where banks acted irresponsibly and ruined the financial assets of investors that the “time for remorse is over”. It was a sad, insensitive comment from a CEO in an industry that the public expected would still be sober given the ruin they brought to many investors and financial system through the casino mortgage financial derivatives. Diamond was forced by the LIBOR scandal to eat his words and resign. The irresponsible behavior of the banks had cost tax payers billions of pounds used in bailing out some of British leading financial institutions. There are important leadership and regulatory lessons to learn from the Barclays LIBOR saga for us in Nigeria.  
CEOs especially those in industries with significant public interest must recognize that they have a responsibility to balance shareholder returns, their quest for huge personal bonus with the larger interest of society. Bob Diamond told the British Parliament that he loved Barclays. He also obviously loved his huge bonuses. He did not however seem to recognize that he also needed to love the society and the public that gave Barclays its charter to trade as Bank. Corporate wealth and prosperity is best sustained when society also prospers as a result of business doing its business. Business must create economic value for society. It should be its “reason for being” and its purpose. Its profit should only be a by-product of doing this. Investment Banking, where Bob Diamond was weaned seemed to have forgotten this over the years as it excessively focused on profits and the bonuses of its managers. Everything else seemed to be worthy of sacrifice to achieve the two. With such poor social ethic with which investment banking has been largely run, it is very easy for its practitioners to move from low social ethic to sheer criminality as the Barclays LIBOR scandal suggests. The Barclays LIBOR saga is another evidence that investment banking needs to be re-invented to have a social conscience. It is however not just investment banking. CEOs and corporate leaders have a responsibility to ensure that their organizations should never lose sight of society and the social purpose of their business even in their quest to create shareholder value. They must be the champion of social ethic within their organizations recognizing that sustainable shareholder wealth creation is only possible when it is balanced with the larger interest of society and its well being. While Bob Diamond may claim, though incredibly, that he is not aware of the manipulation of LIBOR by his traders, he is responsible as CEO for the culture of his organization, its values and the norms of acceptable behavior. By making public statements such as “the time for remorse is over”, Bob Diamond might have signaled to his traders that it is back to impunity, back to “business as usual” as in the old times of irresponsible casino banking.  
The Barclays LIBOR saga also illustrates the limits of self regulation. Unless sufficient safe guards are in place to protect public interest, we should not trust that business will always act responsibly. The process of setting LIBOR should no longer be left to the private British Bankers Association. It has to be taken over by an independent financial service regulator who will balance industry concerns with public interest.  Self-regulation seems to be failing in many spheres. We have seen the limitations of self-regulation in the British media with the abuse of press freedom by the Murdoch’s News of the World. While we will always be uncomfortable with tendency by governments to over-regulate and potentially make markets inefficient, the fact is that we are in an era where business seems to have adopted a maxim of “greed is good”. With increasing industry concentration where few oligopolies control many industries, corporations have emerged far more powerful than their atomized customers and the governments that should protect them. The oligopolies find clever ways to cooperate further increasing their bargaining power relative to their customers which eventually lead to market inefficiencies or even market failure. The case, therefore for strong regulation, for a new era of regulatory activism where industry interests are better balanced with societal interest have never been stronger. Regulation must promote stronger and fair competition. The principle of significant market power must be evoked in public interest industries like financial services, energy and telecommunications to ensure that no player hold so large a share of market as to stifle competition.
The Barclays LIBOR saga also raises the debate whether retail and investment banking should co-exist in the same bank. Investment banking with his inherent high risk, its casino nature where huge profits could be made overnight and the same profits and institutional capital wiped off the next day with trading losses, put retail banking customer deposits and the overall bank capital at risk. Attempts by regulators to prescribe new capital cover for investment banking assets might not have gone far enough. The experience of the last period is that governments using public taxes will still have to bail out the  banks that are “too big to fail” when investment banking fiasco happens in order to protect retail deposits and prevent a disastrous collapse of the financial system. There is therefore an implicit and inherent guarantee of investment banking risk by public taxes that if they go overboard, that governments will step in especially if the banks are too big to fail. It is argued that this in itself tend to make investment banking take excessive risks   as their profits and bonuses can be privatized while their excessive losses could be potentially socialized.  A separation of investment and retail banking will ensure that governments have no reason to intervene if a stand-alone investment bank fails and wipe off its own capital. Public deposits would not have been put at risk. This will significantly moderate excessive casino risk behavior in investment banking and its impact on the financial system. This is a raging debate internationally on the management of the financial system which we also need to have actively in Nigeria. As the Nigeria banking sector gets more consolidated with increasing concentration, and our big retail banks pursue investment banking ambitions, it is critical that our regulators put the right safe guards in place to protect public deposits and the retail business which is a critical backbone of the stability of the financial system.

Olu Akanmu is an executive in the telecommunications industry. He publishes a blog on Strategy and Public Policy on