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By IFR Editor-at-large Keith Mullin
Sept 23 (IFR) - It' official. Compliance, legal and riskhave officially taken over investment banking.
Banks are drowning in legal and litigation costs and reserveaccruals, while the costs of paying the veritable army of riskmanagers, lawyers and compliance professionals are of such amagnitude that they're acting as a millstone around the neck ofthe 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 itsdirection of travel in the five years since Lehman Brothers'collapse has clearly been driven by vindictiveness and a morbidlonging for revenge, but they've created a monster.
The combination of a massive body of regulation that hasturned banks into massive bureaucratic mega-machines with aregulatory apparatus that has become ultra-litigious andpredatory. It is actively encouraging aggrieved or perceivedaggrieved parties to sue left, right and centre, and risksdestroying the fabric of the investment banking industry. Infact, the more I think about it, maybe that IS what regulatorsand politicians wanted
In a world where individual regulatory bodies refuse toco-operate in order to protect home-country rule at the sametime aggressively pushing the cause of extra-territorialcontrol, and where they collaborate at face value only to paylip service to G-20 and Financial Stability Board resolutionsand recommendations, it seems the only place regulators reallywork together is on stiffing investment banks and getting theirpound of flesh in the fines' merry go-round.
RIPE FOR REFORM
Sure, something was definitely needed to reform a financialsector that had got itself into dangerously bad habits - and notjust investment banks, by the way - in the lead-up to the globalfinancial crisis. The industry was ripe for reform but we'vemoved far too far in the direction of over-regulation.Investment banks are becoming functionary-heavy factories. Itmay perhaps be a naturally over-reactive cyclical thing thatwill rebalance as we progress through the cycles, but I don'tlike the look of it.
I've been thinking about this for some considerable time andit's a constant topic of industry conversation. The JP MorganLondon Whale fine offered me the perfect timing opportunity tovent. The severity of the language used in the US Senate'sPermanent Subcommittee on Investigations' March report into theWhale trade was a clear signal that Carl Levin and his merry menwere out for blood and it was clear that the fine was not goingto 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 thechunky side. So what changes will JP Morgan chief Jamie Dimonintroduce? Well, the Wall Street Journal reported that the bankwould spend an extra US$4bn and put a staggering 5,000additional people on the case to fix risk and compliance issues,including 3,000 in risk control and 2,000 extra compliancepeople assigned to the lines of business.
And that is on top of the thousands already engaged in thistask but who are clearly failing to hit the high points. ThatUS$4bn number breaks down into US$1.5bn on managing risk andregulatory compliance and an additional US$2.5bn to litigationreserves.
It appears that the man who is hardly known for his love ofregulators now meets personally on a regular basis with bankexaminers. I bet that's something they look forward to a bitlike the prospect of meeting the grim reaper in a dark alley.
ORDERS OF MAGNITUDE
I'm not sure anyone really knows the true magnitude oflitigation reserves and accruals at the bulge-bracket and othertoo-big-to-fail investment banks. By definition, it's impossibleto really know what's coming down the pipe in terms of potentialfuture litigation. But the sheer amount of litigation noise andthe breadth and global nature of litigation enquiries andongoing investigations give the distinct impression that this isnot going away any time soon.
JP Morgan alone has taken US$5bn in pre-tax litigationcharges in each of the past two years. That's a fair chunk ofchange even for a behemoth whose net income was US$21.3bn lastyear. Peruse the earnings statements of the leading banks andthe numbers are staggering. Going back over the quarters fromthe second quarter in 2013, JPM accrued litigation expenses perquarter 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 Citigroupsaid second-quarter 2013 opex increased by a quarter to US$1.5bnprimarily due to higher legal and related expenses (US$702m insecond-quarter 2013). Bank of America Merrill Lynch's number wasUS$471m in the second quarter of 2013 and US$2.2bn in the firstquarter of 2013; Morgan Stanley set aside US$199m in Q2 andbuilt up an additional US$270m in the first half. Goldman Sachsincluded net provisions for litigation and regulatoryproceedings of US$149m in the second quarter of 2013 and US$259min the first half of 2013.
Non-US banks have similar numbers: Barclays £185m in thefirst half of 2013; £200m in the second half of last year and£187m in first-half 2012; HSBC increased litigation-relatedexpenses by US$600m in the first-half 2013; Deutsche Bank tooklitigation-related charges of 630m in the first half and itslitigation reserves stand at 3bn.
This is crazy. People often talk about laws of unintendedconsequences. Litigation reserves, accruals and charges and tensof thousands of bean counters has to be one of the mostegregious.
The world has gone mad.
