Profit not process: How our banks grew too bureaucratic for their own good

Banks are often accused of making excessive profits. In fact, for the past several years, western banks have tended to be less profitable than they used to be, trading at lower or barely more than their book value. Improved profitability for some banks, resulting from interest rate hikes, is unlikely to change the situation except temporarily.

One key source of inefficiency is the trend for process-driven management, which has grown since the financial crisis of 2007-8, particularly in response to the swathes of regulation that were introduced after that time. 

This has left banks with an unwieldy bureaucracy, reducing the ability for senior managers to exercise judgement and squeezing out vital time for thinking. Ironically, that has given shadow banking – relatively unregulated – a competitive advantage and made the financial system less safe. 

The current fashion is nevertheless to introduce more processes, on the theory that the greater their use, the greater the cost savings and the greater the benefit.

The problem is caused by the way in which many of the processes have been constructed. They are designed to tackle regulatory requirements for areas such as conduct and money laundering, and instruct at a high level how banks must control risk-taking by individuals and groups, and ensure core governance matters are properly addressed. 

Vast inventories of applicable provisions have been created by compliance departments and consultancies, often with a process for every provision. 

What results is unnecessarily bureaucratic and at odds with the needs of businesses as sophisticated and variable as banking. It limits choices for business managers, diverts energies, and creates new risk when unexamined assumptions are made over what is or is not required. 

The problem is exacerbated when the regulators ask questions on the same subject areas, leading to duplication and invariably more process. 

Banks have underestimated the importance of legal judgement. 

The need for such judgement arises at the design stage of new processes. Only at that point can lawyers with relevant practical expertise and experience delve into the detail and identify where problems and flexibilities lie, and what further facts they need. As things stand, those steeped in the facts try to commission advice on what they believe might be legal questions, which means that the input of lawyers is artificially constrained. 

Lawyers are usually only asked for broad summaries of provisions as part of the exercise of producing inventories, which is a method rarely capable of being helpful since they are not being enlisted to think about how the law is to be applied to facts, the core characteristic of legal reasoning. Sometimes their contributions are procured in a way that means they can be too quick or even erroneous in their answers.

Properly defined processes, using more legal judgement and reasoning, would allow senior management to spend more time on the judgement calls which define the success of businesses. 

Adjustments to the way in which Legal departments operate may be necessary to open things up. Some aspects of the role of Legal involve transaction execution, advocacy (i.e. putting the best case, when robust) and disputes. Legal is nonetheless best considered as performing a control function, reflecting the overriding importance of its role as a “protector” of the bank. 

To fulfil this role, in-house lawyers must proactively engage with the business to understand fully the business activity, to assess the risk emanating from it, and to assist senior management in determining which risks to take and how best to manage them. 

From a governance perspective, the General Counsel should report directly to the Chief Executive; direct access to the board is critical. The UK financial regulators have decided not to treat the General Counsel as a “Senior Manager”. This has had adverse ramifications, at least symbolically. The General Counsel needs to be involved in all situations benefitting from legal or regulatory judgement. They should also be central to communications with regulators and the market, shaping the reasoning that buttresses the bank’s position in such interactions. 

The in-house lawyers need to evaluate what they can best do, allowing time for thinking and making efficient use of outside counsel for additional analysis and skills, especially for sporadic tasks. They can use processes to produce first drafts of standard agreements, for aspects of document management and for investigations, through the use of automated production systems, Artificial Intelligence, and cheaper, outsourced lawyers in off-shore locations.

Properly used, lawyers can provide the solution to many of the issues facing the banks, freeing up time for judgement, unlocking value, saving cost and helping to enhance risk management. Lawyers are an essential ingredient to operating the modern bank in an efficient, more profitable manner.