Standard Chartered and Why We Must Change the Way We Police Banks

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Matthew Lloyd / Getty Images

People enter the Standard Chartered bank's offices in London, Aug. 7, 2012.

MF Global, JP Morgan’s Whale Fail, LIBOR rate-rigging: The financial services industry has been cranking out scandal like it’s going out of style. The incidence of financial scandal has become so frequent, in fact, that each successive scandal has some media outlet or another asking the question: Is our financial system incorrigibly corrupt?

But a funny thing happened this week. A large multinational bank settled with a banking regulator over charges of falsifying documents and obstruction of justice and the financial press wasn’t unanimous in its scorn of that bank. In fact, many were accusing the regulators of overreaching and overreacting.On August 6, the New York State Department of Financial Services (DFS) formally accused Standard Chartered, a British-based bank of laundering money from Iranian clients, and then covering up its tracks by falsifying documents and obstructing an investigation by the Department of Financial Services and federal regulators. Sounds like pretty dastardly stuff, so why were many in the media and the financial industry coming to the bank’s defense after the DFS announced a $340 million settlement on Tuesday?

(MORE: The Accounting Trick Behind Thirty Years of Scandal)

The first line of attack against DFS is that they didn’t cooperate enthusiastically enough with the other regulators working on the case. Several other regulators and law enforcement agencies, including the Manhattan District Attorney, the Federal Reserve, the U.S. Treasury Department, and the U.S. Justice Department were also looking into this case, and these organizations were obviously not happy with the DFS going it alone. And many commentators thought that this act set a dangerous precedent for future regulatory actions. As Tim Worstall of Forbes wrote:

“We really don’t want to have multiple overlapping jurisdictions that will compete with each other to see how hard they can be on suspected criminals. We know very well that that way justice itself will be slowly strangled. And yet this is what we do appear to be getting with financial regulation and oversight.”

Without understanding the internal dynamics of the joint investigation, it is really impossible for an observer to judge the validity of this argument. It is entirely possible that the other regulators were dragging their feet on the investigation, or weren’t interested in pursuing Standard Chartered with the appropriate vigor. It is also possible that DFS head Benjamin Lawsky announced the action to steal headlines and raise his own profile. We simply don’t know — and probably never will.

The other argument against the DFS is that it is an example of a too-powerful regulator penalizing a bank in a manner disproportionate to the crime it committed. Because the regulator has the power to unilaterally revoke the financial company’s New York State banking license – the loss of which, by one estimate, would have cost Standard Charter’s 40% of its yearly earnings – it’s leverage in any negotiation is very high. That’s why one cannot assume that just because Standard Chartered settled, it is necessarily guilty of all that the DFS alleged: It’s not hard to imagine a scenario in which Standard Chartered would rather pay the fine than risk such a large piece of its business. Following this logic, The Wall Street Journal alleged that the true nature of the crime is much less egregious, and that the $340 million penalty is therefore too high:

“[Lawsky’s] grandstanding on Standard Chartered may also do more harm than good. For one thing, his declaration of allegations includes some exaggerated facts. Of the $250 billion of transactions at issue, it now appears that $249 billion and change were legal at the time they occurred.

We’re told by other law enforcers that roughly $300 million in transactions over the course of a decade were illegal. This is higher than the bank’s public claim of only $14 million, but a tiny fraction of the amount in Mr. Lawsky’s initial accusation.”

In other words, the crime Standard Chartered committed could have been a matter of a minor carelessness with regards to a complex set of regulations, like the bank claims; or the crime could have been a decade-long pattern of willful flouting of U.S. law and subsequent cover up, like the DFS claims.

(MORE: How Dangerous Is America’s Debt?)

The problem now is that the public will never know the truth. Banks like to settle because they don’t want to air their dirty laundry; because litigation distracts from day-to-day business; and because a loss in court, even if unlikely, could potentially destroy the entire operation. Regulators like to settle because it conserves scarce time and resources that would be expended in a public trial, and eliminates the risk that such a trial would end with an embarrassing not-guilty verdict. But the practice of financial regulators settling with large financial institutions is corrosive to the public’s trust in the system because it’s necessarily such an opaque process.

This is a broader issue that’s arisen many times since the financial crisis set regulators into high gear in search of guilty parties — and many times before as well. But the case of Standard Chartered in particular emphasizes what’s wrong with this approach to regulation. The lack of an open inquiry into illegal behavior merely fuels the paranoia of both the right and the left that either regulators are capriciously shaking down banks or that large banks are merely making small payoffs to get away with illicit acts that are far more profitable than the punishments are costly.

For instance, Ian Gordon, an analyst at Investec told the Wall Street Journal on Wednesday that the settlement was “grossly unjust” towards Standard Chartered, and that the bank

“did this deal to dispose of a fairly unprecedented regulatory assault that could have had a material disruption to their business. When you are a high quality, high growth bank like Standard Chartered, the scope for value destruction was more than $340 million.”

From the other side of the debate, you hear celebratory statements from the likes of Michigan Senator Carl Levin who said in a statement Tuesday that, “The agency also showed that holding a bank accountable for past misconduct doesn’t need to take years of negotiation over the size of the penalty; it simply requires a regulator with backbone to act.”

As far as we know, neither party has any real facts to back up these categorical statements. They’ve simply filled the vacuum left by a lack of a transparent discovery process with their pre-conceived notions of our banking and financial regulatory systems.