European Banks Pay for Their Sins

Legal costs keep climbing as regulators crack down

Bad behavior can be expensive. Since September 2008, the 18 European banks with the highest litigation expenses have set aside or paid out more than $77 billion, five times their combined profit last year, according to data compiled by Bloomberg. And the total is probably higher, because many settlements aren’t public. “Banks aggressively followed a very, very return-oriented business model before the crisis,” says Martin Hellmich, a professor of risk management and regulation at the Frankfurt School of Finance & Management. “Now they’re paying for the past with settlements and fines.”

Regulators are citing European banks for infractions including helping some clients launder money and avoid taxes; selling bonds backed by faulty mortgages; failing to disclose the risk of products designed to protect buyers from interest rate swings; and manipulating market benchmarks. Since late 2008 the 18 banks paid at least $24.9 billion to settle lawsuits and probes, set aside $31.5 billion to compensate U.K. clients who were improperly sold products including mortgage insurance, and earmarked $20.9 billion for additional penalties. The expenses have hurt banks’ profits and slowed their efforts to build capital. Future penalties may prompt them to delay boosting dividends or buying back stock, analysts at Keefe, Bruyette & Woods wrote in a November report to clients.

Lloyds Banking Group, Britain’s largest mortgage lender, and Deutsche Bank, Europe’s biggest investment bank by revenue, together account for about 31 percent of the total, according to company reports. Lloyds is paying more than £8 billion ($13 billion), the most of any bank, to compensate U.K. customers who were sold loan insurance that didn’t cover them or that they didn’t need. Deutsche Bank’s legal reserves of $7.5 billion at the end of September included about $600 million to repurchase flawed mortgages, as well as money to cover a potential settlement with the heirs of a German media tycoon and possible fines for manipulating benchmark interest rates.

Regulators are investigating whether more than a dozen banks colluded to manipulate Libor, the London interbank offered rate, a benchmark for more than $300 trillion of securities worldwide. Barclays, UBS, Royal Bank of Scotland Group, and Rabobank have been fined a total of about $3.6 billion for rigging Libor. The European Commission fined six companies a record €1.7 billion ($2.3 billion) on Dec. 4 for manipulating rates linked to Libor.

Regulators are also investigating the $5.3 trillion-a-day foreign exchange market. Bloomberg reported in June that traders at some banks said they shared information about their currency positions through instant messages, executed their own trades before client orders, and sought to manipulate the benchmark WM/Reuters rates, which determine what many pension funds and money managers pay for currencies. “Libor was the beginning,” Elke König, president of BaFin, the German banking regulator, told reporters in Frankfurt in October. “Now we’re talking about foreign exchange.”

The total of legal expenses calculated for this story is based on the latest available data. Of the 18 banks included in the tally, 17 have assets of more than $500 billion, putting them among the largest in Europe. Spokesmen for the 18 companies, which also include Credit Suisse, HSBC, Italy’s UniCredit and Intesa Sanpaolo, Spain’s Banco Santander, and Crédit Agricole of France, declined to comment beyond disclosures already made for past and future legal expenses, or didn’t respond to requests for comment.

Christian Hamann, an analyst with Hamburger Sparkasse, a German lender, says these banks remind him of Europe’s insurers when they grappled with billions of dollars in claims in the late 1990s related to gutting buildings insulated with toxic materials. “This is the asbestos of banks,” he says. “The insurers knew the risks, but their reserves were never enough, and they only really got a handle on it in 2004 or 2005. The banks have also underestimated their legal risks.”

Spiraling litigation costs haven’t stopped the banks’ stocks from rising. They’ve been helped by the European Central Bank’s pledge last year to help save the euro by buying the bonds of nations that accept certain conditions. Of the 18 banks, the 17 that are publicly traded have seen a median gain of 21 percent this year through Dec. 2.

The $77 billion European legal tab is less than the $103 billion the six biggest U.S. banks had allotted as of late August to lawyers, litigation, and settlements since the financial crisis, according to data compiled by Bloomberg. In October, JPMorgan Chase reported its first quarterly loss under Chief Executive Officer Jamie Dimon because of surging legal expenses. Last month the bank agreed to the final terms of a $13 billion settlement over its sales of mortgage-backed securities.


    The bottom line: On Dec. 4 the European Commission fined six companies a record $2.3 billion for rigging rates linked to Libor.

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