Finance Focus

situations, the risks of funds going missing, and of failure itself, are the most severe.

Although fraud can bring down a bank, it is not the only cause of a collapse. Another cause is irresponsible lending, such as what took place during the mid-2000s. Then, bankers regarded loan making as a source of quick, easy fees and profits. They wanted their deposits out in the market place to capture demand and buoyant asset prices. Many may have been advised by cautious colleagues to avoid some of the more dubious lending propositions, but the opportunities looked endless and almost nobody wanted to miss them. Property in the Gulf States, for example, looked like an exciting investment for high rollers during the early part of the last decade but, when prices collapsed, returns bit the dust. The fortunes of many banks also plummeted as a result of the Dubai property melt-down; some needed bailouts.

Rash lending was also evident in developed markets such as the United Kingdom. While there is no suggestion that criminality was involved, when the bubble burst in 2008, the value of assets built up by companies like Royal Bank of Scotland, HBOS, and Bradford and Bingley collapsed. They too were forced to take multi-billion pound government bailouts.

From issuance of overly risky loans in Britain to insider lending in emerging markets, these asset price collapses exposed banks, as customers lost faith in their solvency and opted to withdraw their funds. Those without lenders of last resort – and their deposit guarantee schemes – could not survive without the funding and failed.

The process of dissecting the loan books of these banks was painful. It exposed breaches of a multitude of banking rules. Contracts and other documentation were severely flawed as bankers rushed to do deals; decisions were taken without proper due diligence; collateral valuations were weak or non-existent. Wherever you looked, fee-making had driven executives and prudence was nowhere to be found. At the very moment when compliance was most needed, it was ignored by deal-makers addled by the adrenalin of the boom.

It has taken some time for the worst excesses to be exposed, although the loss of control was evident in virtually every aspect of banks’ activities during this period. Several instances of alleged rogue traders have appeared in the last couple of years, following on from the discovery of Jérôme Kerviel, the rogue trader who lost Société Générale $4.9 billion in 2008. A similar alleged flouting of good compliance practice was exposed this year with the Libor rate fixing scandal. Banking fraud – once a relatively neglected subject – has now been brought to the front of the public consciousness. Bankers have taken the blame for the recession.

These losses have given regulators a license to act tough. American regulators, for example, have imposed heavy fines on a number of financial institutions for issues such as lax anti-money laundering systems and OFAC breaches. Britain’s Financial Services Authority (FSA) imposed its heaviest ever fine this year for Libor manipulation and European regulators are investigating further such cases. The continued investigation of banking systems

by regulators is likely to produce new allegations, revelations, and even more charges.

Regulators are under pressure to clamp down on bad practice. Banks have no option but to cooperate with their requests and admit to errors. Compliance has become a top priority in the boardroom; even if that means that the bank takes a less aggressive posture in the market and has to lower its return on capital.

Basel III rules on capital adequacy have stopped any attempt to revert to aggressive lending.

Whether the modernized, less aggressive banks are also stronger ones is a matter for speculation. For now, banks are more likely to be picking up the pieces from a period when many either collapsed or came uncomfortably close to doing so. The wisest ones are building up compliance systems and anti-fraud techniques to ensure that the worst excesses will never be repeated, and are pro-actively investigating questionable past practices in a bid to manage the reputational fallout from further regulatory probes.

Brendan Hawthorne is a Managing Director and Head of Kroll’s Dubai office. He has 17 years’ experience in forensic and financial investigations. Brendan has worked on many large and high profile investigations with a primary focus on financial institutions, managing complex international frauds, multi-jurisdiction asset-tracing and large accounting investigations