Business Money – Finance and Banking for Business

The sticky mess of regulatory red tape

January 2005

Bank relationships with business customers are getting more clogged up by regulations, as Michael Imeson reports

Mike Imeson

When the chairman of one of the world’s biggest banks complains about the burden of financial regulation, you know something must be wrong. HSBC chairman, Sir John Bond drew attention to the rising costs of compliance at the bank’s AGM last year, when he said it spent $400m in 2003 complying with its regulatory obligations around the world.

The UK is one of the most heavily regulated jurisdictions, and the provision of financial services to the SME sector is as badly affected as any. Banks now have to treat their SME customers according to rules recommended by the Competition Commission aimed at increasing competition. These rules – imposed between 2002 and 2004 – force the main banks to make it easier for businesses to switch accounts, and either pay a minimum rate of interest on current accounts, or provide free money transmission services.

But the Financial Services Authority churns out most banking regulations. Its anti-money laundering rules, for example, impose numerous obligations on banks, including requiring bank staff to report suspicious transactions and ask intrusive questions to establish a customer’s identity.

Several banks have recently fallen foul of these rules. They have been fined heavily, had their names splashed all over the newspapers and suffered reputational damage. The FSA admitted in October that it had created a culture of fear in its policing of money laundering regulations and said banks could take a more ‘customer-friendly’ approach; this may lead to an easing of the know-your-customer (KYC) requirements.

But any relief is likely to be short-lived. More pain is on the way in the form of the Third Money Laundering Directive wending its way through the Brussels bureaucratic machine. Other FSA initiatives affecting banks’ dealings with business customers include:

Beyond the specific area of competition and financial regulation, there are numerous laws aimed at businesses in general that affect banks’ relationships with their customers. New measures introduced under the Disability Discrimination Act last autumn require all retail businesses to improve access to their services for disabled customers – which is why banks have installed door-opening buttons at wheelchair-height at many premises.

There are also laws on data protection, telephone marketing and environmental protection – under the latter, lenders can be found liable for any pollution borrowers make that they cannot afford to clean up themselves.

All the burdens outlined so far originate from the UK or EU. There are also two major pieces of international regulation that will have a major impact: the Basel II capital accord, which comes into effect in 2006/7, and International Financial Reporting Standards (IFRS), which apply to all EU listed companies from this month.

Basel II requires banks to align their capital more closely with risk and will affect all types of lending, including to SMEs and large companies. Granted, there will be big advantages for banks in terms of better risk management and more accurate pricing of loans, but the combination of prescription and complexity in the accord will cause some initial problems.

IFRS replaces UK GAAP, and in so doing brings about many changes including the way banks account for their lending to businesses.

Again, there are benefits of using internationally harmonised accounting standards, but there are drawbacks as well…such as the cost and complexity of changing over, different treatment of bad debt provisioning, and a more tax-onerous method of accounting for income from finance leases.

In contrast to his chairman, John Rendall, head of business banking at HSBC, which has an 18-20% share of Britain’s SME market, puts a positive spin on regulation – or, to be more precise, on the impact of the Competition Commission’s remedies to open up business banking to more competition. “Our approach was to accept that these regulations now apply to us, and so we must implement them professionally”, says Rendall.

Like many banks, HSBC claims the rules have actually benefited it as well as its customers. HSBC has been a net gainer of businesses, partly as a result of the regulations making it easier for businesses to change banks. “We have won more businesses than we have lost”, says Rendall.

“We saw the switching rules as another way for us to win business, which is why we implemented them ahead of time. We also went public on our switching figures earlier than the required deadline of mid-2004.”

It has not been without its problems. “Any time spent changing our systems to meet new regulations, and time spent by management ensuring the processes are adequate, is time we cannot spend on other things, so there’s an opportunity cost”, Rendall concludes.

Stephen Pegge, head of communications for business banking at Lloyds TSB that has a similar market share to HSBC, says regulation ‘is a fact of life’ and ‘can protect banks as well as customers’, but ‘we’re entering a period of unprecedented increase in the number of regulations’.

Bankers need time to adjust to the rules, especially as they are increasing in their scope and intensity. There is also a degree of overlap between them, “which means you lose certainty over what you are doing”, says Pegge.

He cites business lending as an example. It is currently being affected by three different types of consumer lending regulation:

“All of this will create problems”, he says. “When a business approaches you for a loan, you won’t know for certain which legislation applies. If you set off on one route and discover later that different rules apply, you will have to backtrack and start again under different rules”.

Another problem is the information overload and personal liability that frontline staff - relationship managers and cashiers - face. “They have to absorb a lot of new communications, take time off for training and, in some cases, accept personal liability”, says Pegge. If, for instance, a cashier fails to report any suspicion she may have of money laundering activity, she could be committing a criminal offence punishable by a long jail sentence.

This responsibility has to be balanced by common sense and commercial reality, otherwise there would be so many suspicious activity reports the system would grind to a halt. “We must ensure our people don’t become too risk averse, and the best guarantee of that is to ensure they have an understanding of what they have to do,” he says.

What can be done to stem the flood of regulations? Not much, is the answer – you just have to go with the flow. Once the regulatory wave has washed in, the damage is done. Little victories are possible, as with the FSA’s back-tracking on aspects of its anti-money laundering rules, but the best course of action for bankers is to continue to make a lot of noise when regulations are being drafted, when the authorities are seeking industry opinion.

Laws can then be shaped in their preparation, rather than attempts be made to change them once they are law. This can only work in the case of UK-generated red tape, of course. Anything coming out of Brussels is totally beyond our individual control because Britain’s voice is but one of 25 and is usually drowned out.

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The sticky mess of regulatory red tape