There have been many quick regulatory responses by global and UK officials, and since Northern Rock almost every aspect of regulation has been reviewed and strengthened in some way. All banks now have to hold more top-quality capital, making them more resilient. The United Kingdom is redesigning its regulatory structure to address the failures of the Financial Services Authority (FSA, now FCA, i.e. Financial Conduct Authority) before the crisis. There are firmer mortgage lending standards aimed at preventing loans to buyers without well-documented income and the new Prudential Regulation Authority, which became part of the Bank of England in 2013, is now the UKās prudential regulator for deposit-takers, insurers and designated investment firms. The intention of this new body is to take a more aggressive approach and inspect bank business plans more closely. Further, the Treasury introduced a new Banking Act in 2009, which amends the law on bank insolvency and administration. It specifically includes the possibility of bank directors being disqualified to ensure that action can be taken against those of failed banks. Additionally, the government plans to put in place a ārebuttable presumptionā that a director of a failed bank is not suitable to be approved by the regulator as someone who could hold a position as a senior executive in a bank.8 It will generally become easier to disqualify or bring enforcement actions against directors, even if they were not personally involved in wrongdoing. Further, the question of criminal liability is raised in the report as a more efficient way of deterring financial misbehaviour and incentivising directors to act without recklessness.
8 The plans are included in the consultation document: HM Treasury, Sanctions for the Directors of Failed Banks (HC 1447, HL Paper 236, 2012), para. 3.11. In the document, the government favours legislating to amend the FSMA The necessary legislation of the proposals would be included in the Financial Services Bill. Moreover, according to the Sanctions Report, the measures could be supported by complementary reforms (which the regulators could take forward) to clarify management responsibilities and change the regulatory duties of bank directors. These tough new liquidity standards and personal liability measures might help to incentivise directors to avoid the type of risky strategies witnessed in the past few years. However, they do not go far enough. There is a general agreement that mismanagement, incompetence and reckless risk-taking significantly contributed to pushing many of our banks to the brink of collapse. Although directors can currently be disqualified for unfitness, or made personally liable to contribute financially to their institutionsā liabilities, there remain serious problems with the current system of accountability. Significantly, the loophole remains open whereby a government rescue from insolvency prevents bankers from being held fully accountable for their actions. The directors of a company brought to the brink of insolvency, but rescued by nationalisation or another form of government protection, cannot be disqualified or held accountable for the debts of their failing institutions, no matter how much wrongful or reckless trading they have engaged in. These sanctions only apply to directors of companies that have become insolvent. The new measures are unlikely to change their behaviour, particularly if bankers believe that ultimately banks will not be allowed to fail. The United Kingdom needs a special bank directorsā regime that links the wrongful trading provisions with the aims of the new Banking Act to ensure that irresponsible directors can be held accountable even when banks are rescued. Knowing they cannot evade responsibility for their actions will deter bank directors from presiding over reckless behaviour, whilst providing some redress for those who suffer losses as a result. This is also relevant in regards to the new proposals of a rebuttable presumption of unsuitability. Moreover, the criminal sanctions require serious rethinking, particularly the type of behaviour that should result in a criminal prosecution. Without these clarifications and amendments, the type of contribution that disqualification, wrongful trading and the new government proposals can make, will remain ambiguous.
This chapter primarily focuses on the law in the United Kingdom and concentrates on the question of directorsā recklessness rather than fraud. It is structured as follows: First, it is significant to understand the reasons why bankers have a tendency to take uncalculated, reckless risks. Part 1 therefore discusses two possible explanations for their behaviour. Behavioural psychology provides interesting new perspectives on this question; studies of the ābehaviouralā move reveal that people often do not make economic decisions in agreement with the rational choice model. This is due to a host of irrationalities that characterise individuals in economic settings. The existence of cognitive biases and information asymmetries make bankers susceptible to a number of behavioural actions which impact on their ability to act rationally. Prospect theory ā a behavioural economic theory ā also provides some interesting insights into bankersā behaviour. Decision-makers irrationally seek risk despite the fact that the circumstances should lead them in the opposite direction. Further, apart from behavioural biases, banks suffer because directors are unable to fully understand their institutionsā complex operations. They simply fail to comprehend the risks their institutions are involved in and do not seem to possess the level of understanding of their businesses one would expect. This reinforces the need to provide directors with appropriate behavioural incentives that can, to some degree, diminish their cognitive limitations. Numerous older and more recent cases are suggestive of this.
The current law has not shown itself to be an effective constraint against reckless behaviour. Therefore, in the final part, this chapter critically discusses the legal and regulatory ways that hold directors responsible for their actions in the United Kingdom and that are meant to incentivise them to act with care. Monetary and non-monetary measures, including disqualification, wrongful trading, criminal and strict liability, form the focus of this part, and ways to improve the current accountability regime are considered. By strengthening and refining bankersā accountability, the negative effects of limited liability can to some extent be reduced whilst also offering a partial solution to the problem of moral hazard. Finally, the question of education and culture is considered, albeit briefly. This is significant, as education can be a cheap, cost-effective way to encourage responsible risk-taking. It could inspire those with suitable risk preferences and professional priorities to become bankers.9
9 Note that the terms ābankerā and ādirectorā will be used interchangeably in this chapter.