Banks are drowning in legal and litigation costs, says IFR editor-at-large Keith Mullin
IT’S OFFICIAL. COMPLIANCE, legal and risk have officially taken over investment banking. Banks are drowning in legal and litigation costs and reserve accruals, while the costs of paying the veritable army of risk managers, lawyers and compliance professionals are of such a magnitude that they’re acting as a millstone around the neck of the industry. Such costs risk stifling – or worse strangling – not just industry profitability, but its sense of innovation, creativity and solutions-building.
Was this what regulators and politicians wanted? I doubt it. Actually, let me rethink that … The regulatory discourse and its direction of travel in the five years since Lehman Brothers’ collapse has clearly been driven by vindictiveness and a morbid longing for revenge, but they’ve created a monster.
The combination of a massive body of regulation that has turned banks into massive bureaucratic mega-machines with a regulatory apparatus that has become ultra-litigious and predatory. It is actively encouraging aggrieved or perceived aggrieved parties to sue left, right and centre, and risks destroying the fabric of the investment banking industry. In fact, the more I think about it, maybe that IS what regulators and politicians wanted …
In a world where individual regulatory bodies refuse to co-operate in order to protect home-country rule at the same time aggressively pushing the cause of extra-territorial control, and where they collaborate at face value only to pay lip service to G-20 and Financial Stability Board resolutions and recommendations, it seems the only place regulators really work together is on stiffing investment banks and getting their pound of flesh in the fines’ merry go-round.
Banks have become massive bureaucratic mega-machines with a regulatory apparatus that is ultra-litigious and predatory
SURE, SOMETHING WAS definitely needed to reform a financial sector that had got itself into dangerously bad habits – and not just investment banks, by the way – in the lead-up to the global financial crisis. The industry was ripe for reform but we’ve moved far too far in the direction of over-regulation. Investment banks are becoming functionary-heavy factories. It may perhaps be a naturally over-reactive cyclical thing that will rebalance as we progress through the cycles, but I don’t like the look of it.
I’ve been thinking about this for some considerable time and it’s a constant topic of industry conversation. The JP Morgan London Whale fine offered me the perfect timing opportunity to vent. The severity of the language used in the US Senate’s Permanent Subcommittee on Investigations’ March report into the Whale trade was a clear signal that Carl Levin and his merry men were out for blood and it was clear that the fine was not going to be trivial.
But an invoice for US$920m from the US SEC, Federal Reserve, Comptroller of the Currency and the UK FCA was certainly on the chunky side. So what changes will JP Morgan chief Jamie Dimon introduce? Well, the Wall Street Journal reported that the bank would spend an extra US$4bn and put a staggering 5,000 additional people on the case to fix risk and compliance issues, including 3,000 in risk control and 2,000 extra compliance people assigned to the lines of business.
And that is on top of the thousands already engaged in this task but who are clearly failing to hit the high points. That US$4bn number breaks down into US$1.5bn on managing risk and regulatory compliance and an additional US$2.5bn to litigation reserves.
It appears that the man who is hardly known for his love of regulators now meets personally on a regular basis with bank examiners. I bet that’s something they look forward to a bit like the prospect of meeting the grim reaper in a dark alley.
I’M NOT SURE anyone really knows the true magnitude of litigation reserves and accruals at the bulge-bracket and other too-big-to-fail investment banks. By definition, it’s impossible to really know what’s coming down the pipe in terms of potential future litigation. But the sheer amount of litigation noise and the breadth and global nature of litigation enquiries and ongoing investigations give the distinct impression that this is not going away any time soon.
JP Morgan alone has taken US$5bn in pre-tax litigation charges in each of the past two years. That’s a fair chunk of change even for a behemoth whose net income was US$21.3bn last year. Peruse the earnings statements of the leading banks and the numbers are staggering.Going back over the quarters from the second quarter in 2013, JPM accrued litigation expenses per quarter of US$700m, US$300m, US$1.2bn, US$800m and US$300m.
I don’t want to make this too long a list, but Citigroup said second-quarter 2013 opex increased by a quarter to US$1.5bn primarily due to higher legal and related expenses (US$702m in second-quarter 2013). Bank of America Merrill Lynch’s number was US$471m in the second quarter of 2013 and US$2.2bn in the first quarter of 2013; Morgan Stanley set aside US$199m in Q2 and built up an additional US$270m in the first half. Goldman Sachs included net provisions for litigation and regulatory proceedings of US$149m in the second quarter of 2013 and US$259m in the first half of 2013.
Non-US banks have similar numbers: Barclays £185m in the first half of 2013; £200m in the second half of last year and £187m in first-half 2012; HSBC increased litigation-related expenses by US$600m in the first-half 2013; Deutsche Bank took litigation-related charges of €630m in the first half and its litigation reserves stand at €3bn.
This is crazy. People often talk about laws of unintended consequences. Litigation reserves, accruals and charges and tens of thousands of bean counters has to be one of the most egregious. The world has gone mad.
