Why didn’t UK regulators spot the rot at the heart of British banks?

US investigators have revealed the scandalous culture in RBS ahead of the financial crash. But where were British regulators?

Anyone doubting the inevitability of another banking crash needs look no further than the rotten business culture at Royal Bank of Scotland (RBS).

In case anyone needs their memory refreshed, RBS was the subject of £45.5bn bailout by UK taxpayers. It is currently at the bottom of the customer service league and has already paid US regulators nearly $12bn in fines. It has been rebuked by the House of Commons Treasury Committee for systematic abuse of small businesses and is also implicated in alleged laundering of Russian dirty money.

In May 2018, US authorities levied a fine of $4.9bn (£3.6bn) on RBS to resolve a US investigation into its sale of toxic mortgage-backed securities. Now the US Department of Justice (DOJ) has released some of the related internal emails and correspondence, which provide a glimpse of its corrosive business culture devoted to putting profits and performance related pay before people, ethics and integrity.

The official statements are that financial products, including loans, acquired by RBS are subject to due diligence. But the DOJ said that RBS failed to disclose systemic problems with loan underwriting. 

A Senior Trader said in a May 2006 self-evaluation that when compared to “the rest of [Wall S]treet…we do the least amount of diligence and kick out the fewest loans.” On occasion, RBS did not conduct any due diligence at all. RBS Executives openly (albeit internally) discussed how RBS’s due diligence process was, as a senior bank analyst described, “just a bunch of bullshit.”

The DOJ released transcripts which suggest that in the period leading to its rescue, RBS – through its executives at its US subsidiaries – underwrote mortgage backed securities with a high risk of default, and then made false and misleading representations to sell those to investors. RBS’s chief credit officer described them as “total f***ing garbage” loans with “fraud [that] was so rampant…[and] all random,” so “the loans are all disguised to, you know, look kind of…in a data file.”

Profits before people was the norm, and a senior vice president in RBS’s Asset-Backed Finance Department explained to one of his colleagues that the loans were the product of a broken mortgage industry: the mortgage lenders “raking in the money” had an “incentive…to bring in as many loans as possible,” while “the [mortgage lenders’ employees] that…have the incentive to hold the line don’t give a sh** because they’re not getting paid.”

As the loans became toxic and the US housing market crashed, RBS executives rationalised their practices. RBS’s Chief Credit Officer wrote that the loans were being pushed by “every possible…style of scumbag…it’s like quasi organized crime, ‘[f]acilitated by brokers…and just a lot of bad people who just said, “Hey, there is a major flaw in this loan origination model. And we can fill it up like nobody’s business.” The DoJ notes that RBS never disclosed that these material risks existed and increased the likelihood that loans would default.

The DoJ says that RBS’s executives showed little regard for their misconduct and, internally, made light of it. For example, RBS’s Head Trader received an e-mail from a friend stating “[I’m] sure your parents never imagine[d] they’d raise a son who [would] destroy the housing market in the richest nation on the planet.” The Head Trader answered, “I take exception to the word ‘destroy.’ I am more comfortable with ‘severely damage.’”

The DOJ transcripts are disturbing. Are other banks less rotten – or just counting their lucky stars that so far their internal dealings have not been exposed?

We know that in September 2012 Chancellor George Osborne had secretly written to US regulators urging them to go easy on HSBC, which eventually paid a fine of $1.9bn for money laundering failures – and avoided prosecution.

The Financial Conduct Authority here has also levied some fines on RBS, but has said nothing about the bank’s corrosive culture. Either the FCA’s probes were not thorough enough to reveal the above practices, or it decided to bury them.

The burial may have helped the government which has been busy unloading its shares in RBS. It is hard to believe that HM Treasury was not aware of the evidence collected by the US DOJ. The history of these practices is indicative of possible risks of holding RBS securities and failure to disclose them should put government in the dock.

And what about RBS and its executives who have been indulged by government and regulators? Well, they are threatening to relocate unless they get they get the Brexit that they want.

If losing RBS was the price for cleansing the business culture and avoiding another financial crash, many people may be willing accept that.

Prem Sikka is Professor of Accounting at University of Sheffield and Emeritus Professor of Accounting at University of Essex. He tweets here.

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