The Parliamentary Commission on Banking Standards (the Commission) has published its fifth and final report: “Changing banking for good”. The report contains a package of recommendations intended to raise standards in and transform the culture of the UK banking sector.

The full report (which comprises two volumes) is available here.

As a general comment, the Commission’s report should be regarded as a contribution to current debate on the reform of banking regulation made by parliamentarians who are not part of Government or the regulatory authorities. It is not authoritative, and does not take into account regulatory obligations from Europe or those imposed by the new UK financial services regulators (the Financial Conduct Authority (the FCA) and the Prudential Regulation Authority (the PRA)). It has been heavily influenced by recent banking misconduct that took place under the former Financial Services Authority (FSA) regime, some of which the FSA expressly acknowledged to have arisen from its lax supervision. This conduct is now – in theory at least – far less likely to recur under the new PRA/FCA supervisory regime.

In this report, the Commission focuses particularly on achieving greater individual accountability among senior employees in the banking sector, particularly in the context of recent prudential and conduct failings such as the Libor manipulation, PPI mis-selling and the failure of RBS. However as the previous regulator (the FSA) found, it is very difficult to identify a single individual’s wrongdoing as the cause of a failure. Senior individuals do not make decisions on their own but do so jointly with others including executive and non-executive directors, audit and risk committees and members of executive management.

Based on the argument that the regulators do not currently possess adequate powers in relation to individual conduct, the Commission makes several striking proposals, most notably the criminalisation of individuals’ business decisions coupled with reversing the burden of proof in some circumstances so that the individual director or senior manager must individually prove that the steps they took were reasonable. These steps are most concerning for at least three reasons:

  1. The current system of individual approval and associated risk of disciplinary action has worked reasonably well for over 10 years – most senior managers are fully alert to their duties and concerned to run their banks ethically and effectively.
  2. Criminalising individual conduct when key decisions are usually taken on a collective basis – board responsibility – and reversing the burden of proof smacks of changing the rules to win the game. If a regulator cannot satisfy a court of law that an individual has broken the rules, how can it be fair to make that individual prove the opposite?
  3. Lastly, why would any competent person agree to accept senior office in a bank when, uniquely in Europe and most other advanced economies, they are faced with a series of loaded disciplinary mantraps? If implemented, these proposals could potentially have a dampening effect on positive and beneficial risk-taking which has produced much of the wealth that the UK financial services sector generates.

The Commission’s key recommendations include:

  • A new criminal offence for Senior Persons who carry out their professional responsibilities in a reckless manner. This offence may carry a range of sanctions, including a prison sentence in the most serious cases. In addition, the remuneration received during the period of reckless behaviour by an individual convicted of such an offence would be recoverable through separate civil proceedings.
  • The establishment of a Senior Persons Regime for individuals within banking, replacing the current significant influence functions in the Approved Persons regime. Key responsibilities within banks will be assigned to specific, senior individuals. This is designed to make it possible to identify those individuals responsible for failures more clearly and fairly, enabling enforcement action to be taken against them. However, bank directors and managers who perform “significant influence functions” already make a personal promise in the Statements of Principle for Approved Persons (APER 5 to 7) that the bank will be run compliantly and so it is not clear what this proposal will add. Perhaps the key change is the suggestion that where enforcement action is taken against a firm, the burden of proof should switch away from regulators and onto individual directors to prove that they took reasonable steps to mitigate the firm’s failings. It is unclear whether the Commission has considered if this concept could fall foul of the Human Rights Act and the presumption of innocence under Article 6(2) ECHR, where criminal proceedings are also issued alongside or by way of follow up to enforcement action.
  • The establishment of a Licensing Regime alongside the Senior Persons Regime, covering any individuals within banking (including those within the Senior Persons Regime) whose actions or behaviour could seriously harm the bank, its reputation or its customers. The Licensing Regime would have a wider scope than the current Approved Persons Regime.
  • A new set of Banking Standards Rules to be developed by regulators, applying to all individuals within the Licensing Regime and governing conduct, treating customers fairly and managing conflicts of interest. Breaches of the new standards may lead to enforcement action by regulators.
  • A new Remuneration Code, introduced in order to more closely align risk and reward in banking. Under this, a greater proportion of senior employees’ remuneration is to be deferred, generally for a longer period of up to ten years. The Commission recommends that the form of deferred remuneration should be less reliant on equity, instead using instruments such as bail-in bonds.
  • Directors should be required to ensure the financial safety and soundness of the bank ahead of the interests of its shareholders. It is proposed that this requirement should apply at the very least to those banks above the ring-fence threshold (i.e. those banks which will be required to ring-fence their retail and small business deposit taking activities from their investment banking operations).
  • A proposal that the Government should immediately examine the options for the future of the Royal Bank of Scotland (“RBS”), including splitting the bank and putting its bad assets in a separate legal entity (a “good bank / bad bank” split), and should report on this by September 2013.

Nevertheless in most areas, the Commission has not specified a timetable for its recommendations, nor whether they should be implemented through primary legislation or regulation. The Government is asked to set out a timetable for implementation and specify which recommendations will require primary legislation in its response to the report (which is expected before Parliament’s summer recess).