Quality | 2009.07.25
The bankers' health service | Keith Cuthbertson and Dirk Nitzsche
The Walker review does not go far enough. Finance needs the kind of scrutiny the NHS gets
When banks are "too big to fail" there is a clear public interest in their governance and regulation. Since the taxpayer effectively carries the risk of large losses – witness the recent bailouts – while the private sector takes the upside (including execs walking away with outsized rewards for failure), governance and regulation need to be strengthened.
The Walker committee yesterday rather feebly recommended that the salary and bonus of a limited number of high earners in banks should be disclosed (with names removed) and the board should then show "greater oversight". For the general public to regain confidence in the financial sector, much more needs to be done. The public needs to know that financial advice is independent and authoritative. Such trust can only be built up over time. Consider the National Institute for Clinical Excellence (Nice) which has a clearly defined role within the NHS of assessing technical evidence on the cost-effectiveness of drug treatments for specific illnesses. The financial sector, itself not exactly healthy at present, could do with a National Institute of Financial Excellence. Nife might fulfil a similar cost-justification function on regulatory issues implemented through the Bank of England and the FSA.
Nife could undertake specific tasks and issue authoritative guidelines on broad financial and regulatory issues. There is no reason why some actions of the Bank and FSA, who have demonstrated shortcomings in "light touch" regulation, should not in future be subject to tough scrutiny by an independent, permanent body which takes an evidence-based long-term view. Like Nice, Nife will not get everything right but will be a focal point for independent scrutiny on specific issues, and provide input to any inquiries by parliament.
Sir David Walker rightly suggests that the quality of bank board members needs improving. Nife could therefore start by examining the composition of banks\' boards of directors and suggest what qualifications and upgrading of skills are required as financial innovation leads to new and potentially complex products. After all, we have heard bankers say that the risks attached to some structured products were not adequately understood by them. Nife could draw up a list of eligible persons with the requisite qualifications to be potential directors – probably including many more women who make up about 7% of board members in the UK compared to Norway (which after legislation) now has over 40% women. This could widen the pool of competent directors, compared with the current practice of the less-than-competent choosing others to join their ranks. It could also cross-examine potential non-executive directors on their suitability.
On remuneration a key issue in the Walker review, Nife could pronounce on best-practice schemes, which in any new regime for the crisis-hit industry would presumably involve not only rewards for success but also some clawback for failure. Nife might recommend that performance criteria on which bonuses are paid must include elements based not just on shareholder/business "return" but also some measure of risk. It must also take account of the uncertainty in measuring performance, to avoid paying large bonuses which could be mainly due to luck rather than skill – "The Sir Fred Goodwin Effect".
Some new financial products could be referred to Nife for independent assessment of inherent risks. Had this happened in the past more people may have been alert to the complexity and risks of structured products. It is often in the short-term interests of banks and some employees to sell such instruments and underplay potential risks. If, prior to the current crisis, there had been an authoritative, impartial view on the risks of a range of retail and structured products then maybe the treasury select committee, pension trustees and even some bank executives would have raised alarm bells earlier and more forcibly, thus mitigating the mess we are now in.
A key issue for Nife would be to consider the potential benefits of a permanent equity stake by the taxpayer in banks which are deemed too big to fail – and perhaps the presence on the board of a "Nife shareholder". Such an independent voice could be a focus for whistleblowers within a bank and help ensure risk-management issues are fully considered by the board. This is not "nationalisation" but it may well be in the national interest. If we are to retain "universal banks" rather than split into "deposit banks" and "investment banks" then this is a crucial and timely area for consideration by a body like Nife, especially given the future decisions which will have to be made by UK Financial Investments, the organisation managing the government\'s stakes in banks.
There are no panaceas. Clearly the proposed Nife has a complementary role to that of existing regulatory bodies. But if Nice has been beneficial to the operation of the NHS, a body like Nife might also help to sharpen the regulatory framework in financial services. When the public learns to love bankers, then Nife will have succeeded.
Keith Cuthbertson and Dirk Nitzsche teach at CASS Business School, City University
For more information, please visit
http://www.guardian.co.uk/commentisfree/[...]/walker-review-finance-bankers
