Will StanChart's scandal pull banking back home?

As Standard Chartered drags trust in banking to a new low, there's a growing risk the regulatory response to recent scandals could lead to fragmentation of the global financial system.

FT.com

Is Standard Chartered a rogue institution that conspired with the government of Iran and hid from regulators $250 billion worth of transactions for reasons of pure greed, as the New York State Department of Financial Services asserts? Is the DFS’s interpretation of the law in relation to alleged breaches of the US sanctions regime wrong? And is Benjamin Lawsky, superintendent of this new US financial watchdog, motivated by a desire to undermine London’s competitive edge in international finance relative to New York?

None of these questions can be answered with any certainty at this stage. Note, too, that Peter Sands, chief executive of Standard Chartered, is offering a robust defence, pointing to "factual inaccuracies” in these accusations. What can be said, though, is that the potential damage from this saga extends far beyond a single financial institution – although not necessarily in Lawsky’s hyperventilating sense of leaving the US financial system vulnerable to "terrorists, weapons dealers, drug king pins and corrupt regimes”.

Until now Standard Chartered, whose strength has been built on the growth of emerging markets, has been regarded as having a culture untainted by the excesses that have tarnished other global institutions. Yet the picture that emerges with brutal clarity from emails and other internal documents uncovered by Lawsky’s investigators is of an organisation that cynically manipulated business to avoid the reach of US sanctions in the interests of maximising profit. In moral terms it thus appears no better than HSBC, which was recently shown to have failed to stop money laundering in Mexico and elsewhere, or indeed all the other global banks, including many from the US, which have been involved in ever more egregious scandals.

The cumulative effect on public opinion should be a matter of deep concern. Regardless of the outcome of legal process, the Standard Chartered story is symbolic in that the investigators’ findings appear to provide definitive confirmation that global banking is about grabbing a fast buck regardless of the interests of clients, regulators or reputation. The cultural motto of these institutions, in short, is let the devil take the hindmost.

At one level, the worry is about the challenge to the legitimacy of capitalism. It is hard for people to tolerate historically high levels of inequality in difficult times when they can no longer perceive any moral link between effort and reward at the top. If those at the top are also perceived to be devoid of moral principle in their pursuit of profit, the challenge is dangerously multiplied.

At another level, this all re-emphasises a fundamental problem in a financial crisis that started exactly five years ago. While finance is global, financial regulation is primarily national. Yet there is a growing risk that the regulatory response to scandals could, as a byproduct, lead to the fragmentation of the global financial system. If Standard Chartered and others were to lose banking licences in New York, for example, financial deglobalisation would unquestionably accelerate.

It is easy to underestimate how far the shift to a home country bias in finance has gone already. To take just one example, Morgan Stanley estimates that the eurozone banks’ contribution to big ticket trade finance in Asia fell from 18 per cent to 3 per cent in the 18 months to June this year.

In effect, regulators are increasing firewalls and seeking to trap more capital and liquidity at home, especially in the eurozone, which lacks a lender of last resort facility for cross-border institutions. Eurozone banks have also been reorganising business on a country by country basis to reduce the risk that their liabilities might be redenominated in another currency if the eurozone fragments.

While the European Central Bank has managed to ease funding pressures since December, a trend for banks to match assets and liabilities on a country basis remains intact.

There is a natural, populist temptation to rejoice in the notion that over-mighty financial institutions are being cut down to size and deprived of their global laisser passer. Yet there are costs. Mark Carney, governor of the Bank of Canada and chairman of the Financial Stability Board, which co-ordinates global financial regulation, warned the G20 summit in June that when mutual confidence is lost, retreat from an open and integrated financial world into a nationally segmented system could rapidly reduce both financial capacity and systemic resilience, at high cost to jobs and growth.

The one risk that can be overestimated in all this is of a battle to bolster New York’s financial business at London’s expense. In the 1950s and 1960s tough regulation and restrictive taxes in the US drove financial business to London. Excessive zeal in US regulation and law enforcement today could have much the same effect.

Yet competition between financial centres is a trivial issue when compared with the wider global threat to jobs and growth. The stakes in this unfolding saga are uncomfortably high.

Copyright The Financial Times 2012.