FSA wants new bank punishments

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BBC business editor Robert Peston on proposals to clawback pay

Directors of banks responsible for catastrophically bad decisions, which put their respective banks in jeopardy, could face a new punishment of having two years' pay clawed back from them

Lord Turner, chairman of the FSA, told me that he was attracted to imposing such a sanction - which is part of the so-called Dodd-Frank financial reforms in the US - as a way of discouraging banks from taking excessive risks.

The clawback of bank bosses' pay would be punishment for misguided or stupid behaviour, rather than for illegal behaviour.

He was elaborating on an article he has written in today's Financial Times [registration required], which looks at the lessons of the FSA's investigation of how the Royal Bank of Scotland took itself to the brink of bankruptcy in the couple of years before it was rescued by taxpayers in October 2008.

The FSA has been widely criticised for saying that its review finds no grounds for punishing the senior directors of RBS at the time or the bank itself.

Its decision not to publish the investigation has also been attacked - and yesterday the Business Secretary, Vince Cable, said he was disappointed that no report on the affair has been published by the FSA.

Lord Turner is open to the idea of publishing such reports in the future. However he says that this investigation was carried out according to normal FSA procedures, which makes it difficult to publish because the probe was broken down into separate parts.

Documents were prepared by the FSA's enforcement department on the events leading up to the disastrous purchase by Royal Bank of Scotland of the rump of the Dutch bank, ABN, in 2007, on the control mechanisms in RBS's global banking and markets division, and on whether RBS disclosed accurate information to investors in this period, especially when launching a jumbo rights issue in the spring of 2007.

In other words, a single seamless narrative of what happened at RBS wasn't prepared.

That said, Lord Turner sees the argument that publishing such a narrative could have been useful, in that it would allow future bank directors to learn the lessons of RBS's mistakes.

So in future the FSA may organise its investigations in such a way that a report can be published at the close.

However, the big lesson for Lord Turner of the RBS debacle, and other banking disasters, is that there has to be a cultural revolution in banks, such that bank directors never think about taking the risks that may be appropriate to other kinds of business - not least because the economic damage from bank failures is so great, and because taxpayers are forced by governments to inject colossal sums into the likes of RBS, to prevent them going bankrupt, in a way that almost never happens in any other industry.

Although the kind of entrepreneurialism that leads to bankruptcy may be essential to wealth creation in the hi-tech industry or retailing, it is wholly inappropriate in banking, Lord Turner believes.

For him, RBS's directors should never have contemplated taking on the financial risks that were forced on RBS through the purchase of ABN - and the FSA should have prevented the deal going through.

It should have been palpably obvious to RBS's directors and to the regulators that the deal was leaving RBS with far too little capital for absorbing potential losses, relative to the combined assets of RBS and ABN - and that the deal made the bank far too dependent on unreliable wholesale funding.

That said, these were mistaken business decisions, albeit of catastrophic consequence, not illegal business decisions.

That is why Lord Turner believes there has to be a new, special regime of potential sanctions for directors of banks.

Apart from the US idea of demanding substantial refunds of top bankers' pay, if they make devastatingly bad business decision, Lord Turner also argues that senior bank directors should perhaps be automatically disqualified in those circumstances.

The burden would no longer be on the FSA to prove that the directors had broken laws or rules. Instead, the directors would have to demonstrate that they had taken steps to try to prevent the misguided takeovers, dodgy lending or ill-judged investments that sank their respective banks.

If the directors could prove neither that they had argued against those bad deals nor blown the whistle to the FSA, there would be no uncertainty about their fate, no long review of their behaviour by the FSA: they would face automatic eviction from the bank boardroom.‬‪

You can keep up with the latest from business editor Robert Peston by visiting his blog on the BBC News website.

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