Foreign Bank Settles Charges for "Unsound" Risk Management Practices
Commentary by Steven Lofchie
A foreign banking organization settled charges with the Federal Reserve Board ("FRB") for failing to address known risks associated with a client investor that had an "increasingly concentrated [total return swaps] portfolio."
In an Order, the FRB stated that the client’s total return swaps ("TRS") portfolio became so concentrated that it caused a breach in the bank’s internal risk limits. The FRB found that the bank failed to reduce the risks posed by the client’s TRS portfolio despite the "repeated escalation of red flags" by bank staff. Throughout the client relationship, the FRB said that the bank failed to (i) have adequate processes for reputational risk review, (ii) maintain experienced staff with clear roles and responsibilities, (iii) resolve internal limit breaches in a timely manner and (iv) ensure effective data quality management for risk metrics. When the client defaulted on the bank’s margin calls, the FRB found that the bank lacked adequate margin and caused the bank to liquidate its positions and suffer a $5.5 billion loss.
To settle the charges, the bank agreed to a civil money penalty of $268,494,109. The bank will also take affirmative action with regard to (i) board oversight and governance procedures, (ii) establishing a "remediation office" and (iii) improving its risk management practices for monitoring counterparty credit risk, liquidity risk and non-financial risk.
Commentary
The FRB penalty raises the often-repeated question as to the purpose of money fines in situations like this. As a result of its poor risk management the bank (Credit Suisse) lost $5.5 billion and was forced to be acquired by another bank (UBS). Presumably, the responsible individuals have lost their jobs. One can certainly see the benefits of a study and disclosure of what went wrong. But it's hard to see the purpose of the fine. After all, the bank lost a boatload of money and no longer exists. The acquiring bank and shareholders did not receive a windfall, nor is the acquiring bank at fault. Who is being punished?