Sins of past, present and future haunt banks

The cost to banks of cleaning up past misdeeds has soared over USD 100 billion and is leaving lenders running scared from areas that put them in potential danger of upsetting regulators.

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This week alone, Deutsche Bank, UBS and Lloyds revealed mounting legal bills and Dutch agricultural specialist Rabobank became the latest lender to be fined in a global scandal over interest rate rigging with a USD 1.1 billion penalty.

Bankers fear that paying for the sins of the past and preventing future misdemeanours could be the biggest headache yet for an industry still trying to bulk up on capital and liquidity reserves in the wake of the 2007-09 financial crisis.

"This is a new world of regulation that has emerged post the financial crisis and I think the whole industry is struggling to catch up with it," Mike Rees, head of wholesale banking at Standard Chartered told Reuters.

"Everyone has focused on the liquidity standards and the capital standards, but I think the bigger cost for the industry will be about meeting the standards being required of us in terms of the code of conduct."

JPMorgan - which had emerged from the financial crisis as the poster child for good risk management - is close to a record USD 13 billion settlement with US authorities over the mis-selling of mortgage-backed bonds.

That could take the cost of credit crisis and mortgage-related settlements by US banks to almost USD 85 billion in the last four years, according to SNL Financial. European firms, mostly in Britain, have paid or set aside more than USD 40 billion to compensate customers or pay various fines.

Further penalties are expected to hurt profits for years to come and are encouraging banks to quit business lines and less-regulated countries to shield themselves from future risk.

"Banks have to stand back and say what's strategically important, where's the risk, what's the strategic value? And they have to make some choices," said a senior bank executive.

In many cases, businesses are not worth the cost of policing their potential risks.

HSBC has pulled out of a number of business areas and countries, including Panama and other Latin American countries, since being fined a record USD 1.9 billion by US authorities last year over lax money laundering controls.

The British-headquartered bank, which is spending about USD 800 million more each year on compliance costs across its operations in 80 countries, retrenched from banking embassies and consulates this year, sending diplomats into a panic.

"It was almost a nightmare for us. If we hadn't found an alternative we were thinking about closing down our embassy," said John Belavu, deputy high commissioner for Papua New Guinea in London.

"We had been banking with them for the last 25 years ... it was a big shock for us. We were given six months to find alternative banking arrangements."

HSBC said the retrenchment was a commercial decision based on its review of all businesses since May 2011. Belavu said it didn't give him any further explanation, and his embassy is now with a smaller bank, after other big lenders shunned it.

Credit Suisse and Barclays have pulled out of dozens of less regulated private banking markets such as Belarus and Turkmenistan as the risk of fines outweighs the potential fees from banking rich clients.

With a global clampdown on tax evasion, Barclays has also shut down much of a profitable tax advisory business, which had drawn the ire of British politicians.

After halting the sale of US student loans and exiting physical commodities trading in the face of increased regulatory scrutiny and rising compliance costs, JPMorgan is now reviewing a whole host of other business lines, including cutting services for about 500 foreign banks.

JPMorgan - which has increased annual spending on compliance and risk by USD 1 billion, including adding 4,000 staff in the area since last year - is also reviewing lending to pawn shops, payday lenders and some car dealers, according to a person familiar with the matter.

Britain's banks have warned that tough guidelines on preventing financial crime could see fewer pensions and investment products on offer for retail customers and make it unviable to provide trade finance for smaller firms.

Trade finance has a long list of potential "red flags" as business is screened for sanctions-busting goods or clients, or weapons of mass destruction. A side-effect of that is that all military shipments get bogged down in costly red tape.

Importing any amount of shower gel for soldiers requires one unnamed bank to get the approval of its reputational risk committee, according to a consultation document released by Britain's financial regulator in July.

While there is a general admission among bankers that the industry played fast and loose with rules of conduct prior to the crisis there is also a fear the new zero tolerance regime will push some people and businesses out of the banking net and into the arms of criminals looking to make a quick buck.

Money transmissions, long seen as a weak link in the fight against money laundering and terror financing, are set to get more difficult and costly as big banks withdraw.

HSBC pulled back from the industry last year, and Barclays has this year closed accounts for most of about 100 money transmission firms it banked, putting it under fire from Somalis who had relied on those firms to send money home.

"The people will suffer, the economy will suffer and the security of the country will suffer," said Omar Abdinur, who left Somalia in 1989 and wires money from London to his mother, brothers and other relatives there every month. "Charges will go up and less money will go home."

Somalis living overseas send about USD 1.3 billion home a year, typically for schooling, medicine and food, and about 60 percent of households in the East African country rely on money transfers, according to Oxfam.

Bankers regret the impact their withdrawals are having but with their reputation and potentially huge fines on the line, they say hard choices are inevitable.

"Financial inclusion and de-risking are real challenges," John Paul Cusack, head of anti-money laundering compliance at UBS , said at a financial crime conference last month.

"Everyone is sympathetic to (the need for) financial inclusion, but we're more sympathetic to not being fined, so our first priority is to manage our risk."