Finance Compliance

Finance – Compliance




The author would like to state at the outset that in the wake of the ongoing and rather prolonged international financial crisis, this invasive regulatory approach would be more than welcome to bring about greater stability in global business dealings and finance. The irresponsible acts of banks over the past one decade have led to this recent financial collapse, and it was much worsened by rampant money laundering supported by their irresponsible and lenient policies aimed at generating more profits (Chernoff, 2008). Indeed the banking policy of any country now relies heavily, arguably more than ever before, upon the impact it could have on international trade in a globalized world.


Before advancing the arguments in favour of this policy and examining the effects of the same on the compliance staff of the financial firms around the world, the author would like to discuss the background of this reversal of the previously liberalized and deregulated banking markets Chernoff (2008). The year 2007 saw in the United Kingdom a phenomenon that was later named ‘the subprime’ crisis, where some UK banks were badly affected, and even collapsed, in the wake of irresponsible credit policies. The era of liberalization experienced by the global banking market had finally shown its colours and what happened later affected any and every market and business even remotely associated with the US economy (Stern and Lit van, 2008). At this point, some of the first causalities of the crisis were the much renowned financial institutions such as Lehman Brothers, which was declared bankrupt, and Merrill Lynch, which, due to its losses, had to be sold off to the Bank of America Chernoff (2008). The application of the Federal Reserve’s “too big to fail policy” for its major banks was unable to rescue the economy nonetheless, even though the volume of this crisis was not matched with the collapse of Gold Standard and the German Bankaus Herstatt in the 1970’s (Saunders, 2004).


At this point US’s economically liberal policies were beginning to show their ‘downside’. Hoping to let the “invisible” hand (as formulated by Adam Smith) take care of the impending financial crisis, the US treasury refused help to Lehman Brothers and Merrill Lynch despite arranging a smallish buy out for Bear Sterns and Fannie Mae (Stern and Lit van, 2008). The last casualty was AIG, one of the largest brokerage firms in the United States (Chernoff 2008). The lack of control of the federal reserve of this financially imprudent behaviour of financial institutions led to a rejection of its liberal, non-invasive financial regulatory policies, and since then much emphasis has been placed by politicians and economic policy makers on reinforcing a more conservative regulatory approach towards the banking sector, especially as it is often seen as the ‘backbone’ of the economy.


However, when we look at President Obama’s statement, it is possible to see that the tax payer would have to pay less for banking follies; however, the more controlled the monetary approach becomes the more the tax payer will be paying in the form of the “costs” of compliance being faced by these firms (Polk, 2009). Now that it is being proposed and foreseen that international governments should follow a more controlled approach for their economies where they will closely monitor the activities of any banks that ask the State Bank/Federal Reserve for financial aid (Polk, 2009). This has itself been criticized – (especially by followers of a pure and total free market concept in the USA) – as a burden upon taxpayers as it is said that the taxpayers will be paying for the financial aid that will be given to these failing financial institutions that took defective decisions; after all, the government does not bail out every industry which is failing or which has made terribly irresponsible decisions. However, for future purposes if these rigid regulatory steps are taken up, a large amount of regulatory, monitoring and compliance costs will come in and the transition for the financial firms around the world might itself be costly.


While both the EU and US are now showing a clear intention of having strict regulatory control of ‘badly behaved’ banks, the future economic policies of the US and EU will have to focus on strict regulatory control of such banks and, contrary to the current liberal free market/capitalist policies (based on the notions of the Briton Adam Smith), will have to adopt a stricter interventionist approach for bank regulation.


When we look at banks and the impetus for imposing a stricter control regime upon them, it is important to realize that banks and other financial institutions perform the functions of financial intermediaries that distinguish them from other businesses (Saunders, 2004). Their role is to intermediate liquidity between economic subjects and in this process face a number of risks, which are not true for non-financial firms. While it is true that by taking irresponsible financial decisions they are in violation of their basic functions, the very grassroots of commercial and investment banking are based quite firmly on the laissez faire principle (Hsiao, 2008). It is also true that most of the major economies in the world are signatories to the Basel I and Basel II accords which have played a seminal role in the creation of international banking standards for regulators to prevent imprudent behaviours on behalf of banks (Gerber and Lemke, 2005). The ongoing credit crunch is arguably a result of liberal/capitalist banking lending policies which started with the financial institutions lending at higher rates than usual to the borrowers with a bad economic history and less ability or inability to pay that loan back – (though some would argue that the deregulation of the markets by President Clinton in the 1990’s facilitated this, and others that the true cause of the crisis is the rise of the Chinese economy). This allowed the development of subprime lending functions on the principle of no collateral and higher interests (Goodheart et al, 2005). Further irresponsible behaviour followed when debt instruments were traded and then passed on to other banks or institutions which are ready to take them for the higher interest they got out of them, and at the same time many prominent hedge funds, perhaps deliberately, failed to declare their current asset values as there was no amount of regulation governing this procedure (Stern and Litvan, 2008). The clear lack of invasive regulation and its detriment was well registered at the point when US Federal Reserve witnessed a sudden liquidity crunch with BNP Paribas announcing the freezing of two million worth of its hedge funds (Chernoff, 2008). The Basel committee and the European community also responded with much panic at this point and while the European Central Bank pre-emptively injected 155 billion pounds of into the EU economy; it was clear that something more than financial-market rescue plans were needed here (Stern and Lit van, 2008). The US and EU both set about debating, deliberating upon and signing the relevant legislative measures into law to enforce an entirely new economic framework which would bail out troublesome banks but at the same time subject them to extremely strict regulatory measures. Such legislation and policies authorized state financial institutions to buy sinking financial assets of private institutions to save them from bankruptcy and suspend irresponsible subprime lending and inflationary asset valuation, which is one of the root causes of the recession in the US (Polk, 2009). For example the Basel I&II Accords stress the importance of the creation of international banking standards for regulators in order to insulate banks and depositors from the types of financial risk and capital management from the credit and operational risks which they can be exposed to from the economy through their lending and investment practices (Goodheart et al, 2005). Such measures require the banks not only to ensure that their capital allocation is more risk sensitive, but also to pay sufficient attention to operational and credit risk; all these measures are aimed primarily at countering regulatory arbitrage and ensure depositor protection (Goodheart et al., 2005) Lately, Basel II’s implementation is already underway in the European Union through the Capital Requirements Directives Another initiative aimed at cultivating a more invasive role for the banking regulation is the  GATS agreement Article IV which states that :


“Notwithstanding any other provisions of the Agreement, a Member shall not be prevented from taking measures for prudential reasons, including for the protection of investors, depositors, policy holders or persons to whom a fiduciary duty is owed by a financial service supplier, or to ensure the integrity and stability of the financial system. Where such measures do not conform to the provisions of the Agreement, they shall not be used as a means of avoiding the Member’s commitments or obligations under the agreement (Article 4).”


While the commitment of the above to the eradication of irresponsible bank behaviour cannot be overstated, it needs to be recognized that proper regulatory measures can only be taken at the most domestic level. However, the EU has shown a much more invasive approach to its member states’ financial institutions and a compliance driven climate with strict monitoring and review requirements emerging accordingly (CP, 2008).


Keeping in mind the observations above, it is now best to focus upon the very basic types of problems in financial compliance that could be faced by international financial concerns as well as local firms dealing nationally. An example can be taken from the EU approach to regulating monetary policy pertaining to depositor protection (CP, 2008). Before the recent regulatory measures, which were undertaken to restore depositor confidence in banking, there were few or no guarantees for consumers holding bank accounts with foreign banks. Indeed, the greatest hurdle for prudential regulatory compliance was the large presence of foreign banks (represented through the Association of Foreign Banks/AFB) doing business in London and the UK, which operate through branches, subsidiaries and representative offices (AFB, 2008). These banks in London spoke out against the compliance and regulation-based burden inflicted upon them due to the mere fact of their jurisdictional presence within the EU or the United Kingdom. It is at these points that enforcing compliance becomes difficult. At the same time, banks operating in different jurisdictions might feel over burdened by the additional staffing and compliance costs while trying to work within the ambit of regulation (AFB, 2008). The Financial Services Compensation Scheme in the United Kingdom faced a similar level of hostility to its plans a while ago when it stated that:


“It seems to us wholly inappropriate to extend deposit protection into the business and wholesale arena and it could have unintended consequences of a major nature affecting foreign banks operating in the wholesale markets. This proposal would affect them not only as potential contributors through any FSCS scheme but in establishing procedures and incurring information technology costs in order to meet UK requirements which have little or no benefit for them. We strongly urge that deposit protection should not extend beyond the retail sector however that should ultimately be defined.” (AFB, 2008:1).


The message from the above concerns rings loud and clear. The foreign banks would clearly not want to be bound with compliance; however, the tightening role of the EU policy denotes otherwise (Polk, 2009). Coming again to the example of the FSCS (the financial services compensation scheme) which protects customers of financial services products, this scheme makes it mandatory for all banks operating within UK jurisdiction to subscribe to its regulatory requirements (CP, 2008).  In the event of bank failure this scheme indemnifies the depositor claims to a certain degree. While ensuring compliance in this case, it can be analyzed that the states follow a strict regulatory mode (CP, 2008). This is a consumer protection model as a response to all the banking risks, which ultimately affects depositing banks and the procedural validity of their accounting procedures. A common criticism of such schemes is apparently their failure to use proper legal measures for enforcement.


In the case of the FSCS, it is possible to see that the law itself is seemingly not very helpful to depositors in the event of insolvency of large financial companies (AFB, 2008). These regulatory model and compliance requirements have been a subject of criticism too due to their unreliability and accounting policy. Another issue with compliance is that of transparency v. confidentiality. Under the upcoming money laundering laws banks might be caught in the dilemma of maintaining and investigating certain deposit accounts showing suspicious and fraudulent money laundering transactions (Stern and Litvan, 2008). The problem with stringent disclosure requirements has also been identified as causing UK financial markets to lose sensitive and strategic details, especially those depositing banks who provide liquidity to investors on-demand (Polk, 2009). This arguably makes UK and EU banks less competitive than their foreign counterparts, and equally foreign banks might be reluctant to invest in such locations due to increasing costs of compliance.


The perceived effects of these invasive monetary policies in terms of compliance as adopted from the observations of Polk (2009) are summarized below:


1-     At the national level, local fiscal authorities will find themselves enforcing compliance mechanisms and setting out guidelines in terms of the agency practices, situations for managing conflicts of interest and ensuring transparency of rating a financial institution’s credentials based on its compliance performance.

2-     Much work will have to be done worldwide to bring about harmonized international standards for the rating of financial institution credentials, which manage conflicts of interest. Such methodologies will have to reflect transparency and best practice. A good example is the current role of the FSA regarding the same.

3-     The Central Fiscal authority of any country with its role of implementing these best practices and statutory requirements would then have to be subject to coherent federal supervision.

4-     The same authorities would have to monitor the implementation of consumer regulations with in financial firms including non-banking institutions.

5-     The financial policies in line with more invasive monetary regulation will then have to work towards the unification and strengthening of registration standards for financial intermediaries and loan providing firms.

6-     New licensing requirements will inevitably come into place thus setting standards for registering and licensing foreign banks as well as new local entrants into the banking market.

7-     The trend of naming and shaming will be very useful in this regard, and regulatory authorities will have to set out guidelines for publishing the names and addresses of non-compliant financial firms, which could pose a risk to the economy. One alternate would be to set out criminal penalties for non-compliance. If however that is not the case then civil liabilities followed by a general warning to the public of using the financial services of the same at their own risk would be a much more conducive to securing more efficient compliance.

8-     In addition to setting the higher minimum net worth standards for originators, the financial regulators will be faced with the tasks of establishing and facilitating registration and licensing regimes for such financial service providers, debt counselors and collectors as well mortgage sellers (Arnold, 2005).

9-     The compliance officers will be coming down with more difficult jobs within their roles in financial firms. While it will be a challenge to bring about and manage the change within their respective organisations in terms of the new legal frameworks their role will be to advise their firms in terms of transparency and balancing the need to handle their firm data confidentially with the relevant disclosure requirements (Polk, 2009). The compliance officers will have to be trained and informed of their duties of notifying the main prudential regulators of significant issues and of sharing confidential reports with them. A compliance officer would have to know when a matter regarding the business of the agency had to be discussed or brought to the notice of the prudential regulator (Polk, 2009).



Last but not the least, invasiveness of monetary policy always brings up matters of sensitive financial information held by the banks about their customers as well as their own business. It can be suggested that, following the US example, these international fiscal systems could adopt a principles-based approach which will make the life of the compliance officers much more easy in terms of helping them decide what is the appropriate disclosure for consumer credit and other financial products (CP, 2008).


The legal framework can possibly deal with imposing a duty of “reasonableness” upon the compliance staff of these firms to act in the best public interest while dealing with the financial data of loan providers and intermediaries and know their duties in terms of mandatory disclosures and communications with the clients of the companies (Polk, 2009). Such a duty would apply to all the activities of the clients and would include marketing and soliciting activities of the relevant firms in deciding whether the firm is in fact being not just ‘technically’ compliant but also clearly non-deceptive. Disclosure requirements for the compliance officers are essentially a balancing exercise between abiding by the law while risking legal penalties for negligence in doing so, and at the same time keeping the financial firm’s best interests at heart (Polk, 2009).


In conclusion, it is possible to see that there will be a great many anticipated changes within the ambit of local firm structures after these tight monetary policies are enforced around the world to ensure more responsible banking. Certainly, the job of compliance officers around the world is about to get tougher as they ensure proper administrative action on behalf of an organisation and ensure that the compliance actions save them and their organisations from civil liability.




  1. b)

Taking the two divergent approaches from the UK and EU, the author sets forth two different regulatory models below. One is based on the current Financial Regulatory reform being considered in the US now (Macro-prudential Approach). The other approach is Macro too, but based on the EU system of governance following a more decentralized system of governance.

One of the models the author would suggest if the application of the macro-prudential approach to financial regulation (Polk, 2009): the approach which has been endorsed by the 2009 US Administrations White Paper on Financial Regulatory Reform (US White Paper, 2010) and which is focused upon strict regulatory reform by adding more supervisory authorities upon the banks and merging the role of the main prudential regulator with those authorities responsible for regulating business conduct. Such a framework would ideally encompass giving a stronger ambit of power to the main regulators like the Federal Reserve and Clearing and Oversight Council. Furthermore, strict regulatory compliance in line with the guidelines envisaged by the Basel I and II accords would mean that possible money laundering and investment fraud could be countered by registration of advising agents for hedge, private equity and capital funding (Polk, 2009). The regulation of the buying and selling of derivatives, along with the establishment of better consumer financial authorities, could herald a new era of stricter and more invasive regulation for banks. This model is desirable in the wake of the lessons learnt from the subprime crisis, which has ailed the International Financial and Banking industry since 2007; moreover, the public now expects banks to behave responsibly especially as public money – i.e. people’s taxes – rescued the banks from their self-inflicted disaster. The US White Paper (2010) has even suggested that the decentralization of power to regional Federal Reserve banks should be abolished in favour of one main financial regulator. Despite the need for better and more responsible banking, such an idea is, to say the least, dangerous. The absolution of power would require due accountability as well, and as such that could take a while to bring up the necessary legal and regulatory framework to ensure financial accountability on behalf of the regulators (Stern and Litvan, 2008). An alternative approach would be to call for a committee of regulatory bodies, rather than leaving the power arbitrarily to the Federal Reserve or to the main regulatory body. Indeed, such a concentration could inevitably lead to an impending constitutional crisis due to the number of new powers which will have to be delegated to a more powerful regulator now and would, in effect, bring about the undesired outcome of politicizing the financial regulator. But it can be counter-argued that such an approach would facilitate the means to an end for a tighter monetary policy, which does not favour overtly ‘grandfathering’ financial institutions by comforting them too much during bank failure.


The other model is that of the EU based approach where the main regulator does not have the strict invasive control as that envisioned in the US’s future invasive regulatory approach, but through which an ample use of compliance regulation is made to bring about more responsible banking within the EU Member States (Arnold, 2005). This is the new era EU approach and could, essentially, be more conducive to the aims of stricter bank control (Stern and Litvan, 2008). This approach does not put its confidence in appointing one financial regulator, but has a committee-based approach, and the countering of bank failure and prudential regulation is divided between the European Systematic Risk Board and the European team of Financial Supervisors (Saunders, 2004). It is possible to discern from the upcoming ‘EU’ approach to regulation (which does envisage a tighter monetary policy), that there has to be a much better balancing act between the powers being provided to both bodies and their division in terms of the monitoring and assessment of financial stability (Hsaio, 2008). This policy would operate on less absolute terms, as banks would be issued non-binding risk warnings and recommendations. In such a scenario, there is no main centralized regulator and ideally the European Systemic Risk Board would rely for its election upon the decisions of the various European Central Banks (Hsaio, 2008). The other tier of this EU financial supervisory and regulatory model would be the European System of Financial Supervisors combining the relevant Banking, Insurance and Pension Authorities. This would allow for accountability of the system nonetheless, but the constant criticism of the rather complex, bureaucratic style of EU supervision holds true in this respect as well.

In conclusion, if both systems were to be compared, the author would support the EU’s decentralized approach to monetary supervision rather than concentrating the power in the hands of just one regulator in the interests of better accountability and the health and wealth of the financial system itself.






























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