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Photo Credit: Chase Kindberg (via Flickr)

The latest, in a series of reports on misconduct in the banking sector produced by Quinlan & Associates estimates that as of 2009, banks have lost roughly $850 billion in profits due to subprime mortgage write-downs, rogue trading practices, failures in anti-money laundering, countering terrorist financing compliance (AML/CFT), and other high risk or unlawful behavior. Quinlan & Associates suggest the amount of misconduct related fines for the largest banks is not likely to subside but rather continue to increase from $324 to $400 billion by 2020.

None of this comes as a surprise considering the media coverage of BNP Paribas and HSBC’s involvement in international money laundering schemes and the WellsFargo false account scandal. It is somewhat curious that the growth in misconduct related losses run parallel to an increase in compliance and control investments – which have doubled since 2009, amounting to approximately $173 billion.

With such poor performance from the higher earners, it is no wonder that smaller banks in developing markets often get embroiled in domestic or international financial scandals, as seen is the recent case of the Slovenian state-owned bank, Nova Ljubljanska Banka, accused of laundering €1bn from Iran, in violation of counter terrorist financing and international sanctions. In this era of pricey risk management and compliance investments, there are legitimate questions of why this continues to occur and what can be done about it.

The Financial Stability Board (FSB) report suggests that financial sector misconduct results from persistent risk governance gaps which should be viewed as serious prudential risks as much as general compliance failures. Financial sector institutions should incorporate governance risk mitigation into the day-to-day decisions of all business units – adopted as a first line of defense and integrated as part of the code of conduct.

Unfortunately, too often, compliance risk management is seen as abiding by laws, regulations and rules – rather than an investment in instilling ethical behavior in a company culture. According to Quinlan & Associates’ data, the banking sector is failing to take a company-wide approach and continue to house risk management, compliance, and internal audit functions, far from employees and management. A company-wide culture of integrity, where the “tone from the top” is reflected in the functions and incentive structures of an organization is lacking across the sector. The FSB further proposes strengthening external supervisory and regulatory functions, including a clear mapping of internal responsibilities for mitigating misconduct risks where they occur – usually everywhere but a compliance department itself.

The financial sector would benefit from the basic exercise of assessing whether integrity and ethics can be integrated to achieve profitable growth, otherwise the losses and fines from misconduct will continue to negate any investments in compliance.

Jelena Jolic is a Program Officer for the Global Alliance for Trade Facilitation at CIPE