Regulation Does Not Make Banks Safe!

Banks are supposed to be regulated but it seems that the job has become next to impossible or extremely challenging to perform properly, even when investigative journalists have already collected and published damming information.

Recent examples in Europe during the last few weeks and months point to a clear failure of competence in major financial centres. One can only imagine what happens in smaller financial centres where human resources are more limited and possibly less experienced in matters linked to financial misdemeanours. 

Concrete examples of systematic money laundering from banks located in the in the Nordic countries highlight such regulatory failures.

Banks continue to grow in size and have become so large and complex that it is already clear that top management cannot possibly understand what is really happening in trading rooms or in far-flung branches.The last financial crisis that started in 2008 has pushed bank consolidation even further. There is little reason to believe that regulators are able to follow what is going on in the banks they are meant to regulate and supervise.

The two most recent examples of banking wrongdoing that was missed by regulators and continued for years are the WireCard and Greensill cases.

Wirecard was a payments provider and Greensill a trade finance provider. Both companies had banking subsidiaries as part of the group structure and both were subject to regulatory supervision, or should have been, in major financial centres in Europe and Asia.

Many large banks are participating directly and indirectly in many newly developed activities that involve massive volumes in very high risk areas. The risks relate to volatile asset prices traded by these activities and to the credit risks of the partners and other involved with these partners.

Exmples of these activities and partners are as follows:

    • Banks and their partners are running what is called High Frequency Trading activities where bonds and equities are traded automatically by computer systems running on complex logarithms. The volumes are massive where buying and selling of millions such assets can take place in minutes throughout the day. 
    • Many international banks are supporting or promoting partnerships with hedge funds, private equity companies and SPARCs. Readers are encouraged to delve into the financial press for more information about these rather speculative activities. 

The two failures mentioned above, WireCard and Greensill, illustrate that regulators are far from competent or adequately manned to control what they are meant to regulate and supervise.

The risks created for banks by these two sets of activities are clearly underestimated or not appreciated. But that is another topic to be discussed in future columns. The two latest cases are set out below.

The WireCard Case

It took the German banking authorities over 5 years to find that WireCard was a fraudulently run payments and banking company, even though the Financial Times (FT) had found and published very compelling evidence of wrong-doing based on whistleblowers’ information from 2015.

The Germans were enthralled with their fast expanding Fintech company. It was held up as a national champion. These people regarded the FT’s stories to be based on Anglo-Saxon spite! The German regulators, WireCard’s Supervisory Board, their auditors, EY, and many other senior public figures either defended WireCard or did not probe into the allegations made by the FT for years.

WireCard fought the FT with allegations that they were using fake documents, and that the FT was corrupt. WireCard claimed that the FT was in league with short-sellers of WireCard’s shares. According to WireCard, these short-sellers were able to sell shares ahead of negative news about WireCard that FT was publishing. WireCard insinuated that the FT was giving advanced warning of such negative news to the short-sellers, who could then repurchase the shares at a lower price when the news was published.

WireCard also employed expensive and well-known lawyers to defend the company as well as dozens of private investigators to spy on FT journalists. In the end KPMG was appointed to provide and independent audit to look into the FT’s reports. However, this audit took months of work from KPMG to discover the fraud even though the FT had already collected and published much of the relevant information on possible wrongdoing.

Companies like WireCard had thousands of companies they owned that even made payments to themselves to show revenues and paper profits… the regulators had no idea how to trace this activity and probably still do not.

In the end, the truth of massive fraud that the FT had revealed was understood and the company collapsed leaving shareholders with huge losses and with a number of the senior management going into hiding with stolen fortunes – some say that they are in hiding in Russia, Belarus and the Philipines!

The Greensill Case 

Greenhills case is somewhat similar and involved regulators in Europe, Australia and elsewhere who failed to spot that the company was involved in trade finance operations where a few large companies in poor financial health were being financed by Greensill through banks, insurance and investment funds without the true credit risks being disclosed. The biggest risks were concentrated with a heavily-indebted steel tycoon Sanjeev Gupta’s troubled empire called GFG Alliance.

The amounts involved are in the tens of billions of Euros and involved international banks like Credit Suisse, and big investors like SoftBank. Greensill had also managed to secure David Cameron, the former UK Conservative Prime Minister  as an advisor to Greensill. This too proved to be a deliberate attempt to create a conservative and trustworthy image for the company. 

In Germany, Greensill had a banking subsidiary that took deposits from the cities and other regional governments in Germany. Their losses amount to over €500 million now that Greensill is in bankruptcy – none of the deposits were covered by federal deposit insurance, yet the bank was regulated and supervised by the German BaFin, or should have been…

The Lessons of the Above

If you can really believe that banking regulation and supervision is under control then you are extremely naive! There can be no doubt that the size and importance of banks and their related activities and partners are far beyond the competence and control of the banking supervisors.

The costs of failure are massive and their regular occurrence are clear evidence that all is not safe.

Readers should understand that one of the clearest signs of problems was the fact that WireCard was showing huge profits from revenues that the FT and payments professionals knew was not possible. Their scepticism proved to be correct.

One can look at the international payment ecosystems that are known not to be transparent. Paying through bank can take days and paying through companies like VISA, MasterCard, PayPal, Klarna, Stripe, etc can be expensive albeit convenient. 

We are also can see from following business news that many of these payment service companies are valued in their billions, while we also can see that there is widespread money laundering and wrongdoing from both banks and service providers. Many of these companies are not making money and are posting losses, even when valuations are sky-high. 

We should be asking many more questions about this infrastructure and the legislation and rules that govern them.

It is worth recalling that opening any bank account requires lengthy questions about who you are and how you intend to spend you money – the KYC requirements – yet I can make payments tomorrow to any Tom, Dick and Harry using Bitcoins and other non-banking service providers. 

At the moment the sheer number of banks and service providers provides easy access for hackers to attack and receive ransoms. This needs to be stopped.

Using the same arguments, all dark payment systems that result in payments being untraceable should be banned by international agreements. 

Bitcoin is a prime example of such an activity that should be banned. It allows money laundering and ransom payment to hackers. Global financial losses are phenomenal. That Tesla has started to use them is a nonsense, that represents a highly risky exposure for shareholders. Tesla has no control over the extreme volatility of Bitcoin values.

Making a payment to another for normal trade is a public good for which we do not need this ecosystem of banks and service providers, and certainly no need for digital currencies like Bitcoin. 

Today’s payments are nothing but digital bits of data that do not require 1% to 3% commissions every time a computer key is punched. Domestic payments and international payment between trusted public intermediaries is all that is needed. This could be the foundation for the future that would stimulate economic activity and reduce criminal activity that is flourishing in this sector.

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