Do regulator fines change the behaviour of financial firms?
Updated: Nov 17, 2020
They say that you get wiser as you get older. Well 10 years ago, almost to the day, I wrote a blog on "Do fines change the behaviour of financial firms?" I have just reread it and despite the time that has passed and that the regulator has changed names and management, the outcome of the analysis is more compelling than before - as I will set out below.
In 2010, I recorded that we had just seen the FSA in the UK, as well as regulators in other geographies, hit the record books with larger and more numerous fines for misconduct – e.g. for poor reporting, or handling of customer data. These fines were supposed to be a deterrent and to change the behaviour of market participants. However, the increased size and continued frequency of these fines would suggest that this strategy was/is not succeeding. If they were working then surely at least the frequency of new fines would decrease, or are they not yet at a sufficient level to change behaviour? So what are we supposed to make of the record fines imposed in 2019, including as reported it the FT the largest FCA (the successor to the FSA) fine of 2019, a massive £102m penalty issued in April as part of a global $1.1bn set of measures to settle charges that a bank violated sanctions and ignored red flags about its customers. So over the years, the pattern of fines has remained remarkably consistent - lending weight to the argument that they lack of impact or effectiveness.
My ten years younger self suggested that the evidence could be seen as mixed. For example, those who believe in the effectiveness of fines, no doubt the regulators, will say that, like other policing functions, the more effective their detection becomes, the more transgressions will be discovered and hence the reported level of misconduct seems to rise when it may just be that the detection rate is rising. Similar arguments have been made over the volume of Suspicious Activity Reports leaked recently for the UK and other markets. Maybe more fines and more SARs just reflect better detection? Today this has a strong resonance with the discussions on Covid testing. However, as with Covid we see that better detection does not explain the consistently high level of fines.
Another argument put by the then regulator is that the fines that are being reported now are the result of investigations that may have started several years ago. Hence there is a lag between the original behaviour
and the time the full deterrent effect kicks in. And so the logic goes, the perceived level of offences will get worse before it gets better even if fines are effective. However, looking at this over the 10 year history suggests that these arguments do not hold water - there has been no obvious improving trend.
Those that argue that the fines are ineffective will also point out that a fine levied on an institution is less effective as it is less connected to the individuals that are at fault. Also they will say that the higher frequency means that it becomes too blunt an instrument as most firms will be fined at some point in the recent past. Also the reputational risk impact is shorter as there will be another fine for another institution in a short while that will deflect the public spotlight onto the next firm.
So on the question of whether fines change the behaviour of financial firms, it seems highly likely that fines are good for making headlines, but bad for changing behaviour. Financial institutions may simply continue to see them as an occupational hazard, a necessary cost of operating in complex regulated financial markets. So what should be the next step for Regulators? Some suggest only jail time for senior bank management will work.