(Photo: Reuters)
(Photo: Reuters)

Will criminalising behaviour by 'reckless' bank leaders act as a greater deterrent than sanctions already available under Financial Services and Markets legislation?

This is one of many questions The Law Society posed in its response to the Treasury's consultation, where it proposed to introduce criminal offences targeting reckless conduct by senior bankers.

Following the banking crisis of 2008, the debate about 'what to do about banks and bankers' has been a recurring theme.

Last week the Financial Services (Banking Reform) Bill, the government's legislative response to the financial crisis, received another airing in the House of Commons.

The amendments before Parliament follow Treasury's endorsement of recommendations made by the Parliamentary Commission on Banking Standards in its report, Changing banking for good.

At the heart of the report is a desire to increase regulatory control.

Of concern to many, in the City and in the wider business community, is whether these reforms will achieve their aim and what might their unintended consequences be?

Criminal Sanctions Will Not Improve Banking Standards

The Law Society argued against the proposed new criminal sanctions on legal, practical and wider economic grounds.

We remain un-persuaded that such sanctions, or even the threat of such sanctions, would deliver a systemic improvement in banking standards or the desired change to bankers' behaviour.

The introduction of a criminal offence of 'reckless misconduct in the management of a bank', to carry a custodial sentence, flies in the face of the Treasury's acknowledgement that, in order to define what constitutes recklessness, there must be a clear idea of what constitutes acceptable or "non-reckless" risk-taking.

The Law Society has expressed serious concerns that there is insufficient definition and structure to the new offences.

A badly drafted law could seriously inhibit the flexibility of organisations and their willingness to innovate and take decisions.

Risk-Taking Is Still Needed

Sensible risk-taking is at the heart of effective banking.

There is no definition of "failure" in relation to banks and the target of the proposed new measures is also unclear - the consultation refers interchangeably to 'directors', 'senior executives', 'board members' and 'senior managers'.

Just who is to be caught by the legislation?

And here's where the next problem is likely to strike.

With uncertainty about the application of these new offences hanging in the air, the prospect of criminal sanctions may deter risk-taking among bank leaders or discourage experienced, well-qualified candidates from taking up senior positions.

This could lead to struggling banks facing a vacuum of quality leadership at a time when they most need it, perversely resulting in poorer decision making and overly defensive banking that could harm the wider economy.

Central to the debate and the Law Society's Banking Reform Working Party's ongoing scrutiny of the banking reforms is the need to balance risk, reward and now this concept of 'recklessness'.

The legal test of recklessness will mean prosecutors will have to decide, possibly years after the decision was taken, whether it was reckless or not at the time.

Businesses Could Become Risk Averse

The effect of this is that businesses will become more risk averse.

Businesses may become wary of making bold but legitimate business decisions in case those decisions are deemed reckless years later, measured against the backdrop of a vastly different business environment.

Business decisions will always involve a degree of risk; the commercial environment is unpredictable and, while a decision may be characterised as reckless with the benefit of hindsight, at the time it is taken it may be a perfectly reasonable course of action.

More conservative decision-making and a box-ticking culture removing sensible professional judgement and prudent risk-taking - the likely result of these measures - would hinder growth and act as a drag on recovery in the wider economy.

Insufficient evidence has been advanced to justify these new measures when regulatory measures currently in force, and recently reinforced by the Financial Services Act 2012, would be quicker, more transparent and deliver more effective enforcement.

Regulatory powers offer the right balance between effective deterrents and punishment of infringements.

These, coupled with civil remedies to ensure irresponsible individuals cannot continue to work in the industry, are readily available robust tools at the disposal of regulators to hold financial institutions to account.

Criminalisation of bank leaders may satisfy the public craving for revenge but is unlikely to deliver us better banks.

Desmond Hudson is the CEO at The Law Society, which represents solicitors in England and Wales.

From negotiating with and lobbying the profession's regulators, government and others, to offering training and advice, The Law Society aims to protect and promote solicitors across England and Wales.