Britain's financial regulators are increasingly using so-called skilled person reports to probe the quality of banks' regulatory reporting, such as those issued to Goldman Sachs Group Inc. and Morgan Stanley, and the rise of such reviews is expected to continue.
A bank that receives a Section 166 notice from the Bank of England, which declined to comment, must pay for the cost of the probe into their regulatory reporting by independent accountancy or law firms, even if the review gives it a clean bill of health.
As well as Goldman Sachs and Morgan Stanley, which both declined to comment, other banks including Bank of Nova Scotia and Bank of America Merrill Lynch are expected to face similar scrutiny, according to Sky News.
The number of Section 166 reviews has increased 16% to 51 in the 2018-2019 financial year compared with the previous year, said accountancy firm BDO LLP, the first such increase in five years amid concerns about widespread financial reporting failures.
One banker close to the issue said these initial Section 166 reviews were only the start and that many more were expected over the year ahead as regulators probed the integrity and stability of the banking system. The notices can lead to fines for banks if regulatory processes are found to be inadequate.
"It is not just four banks. These are some of many, many firms which are going to be subject to this kind of review as the regulator acts 'prudentially' to make sure liquidity and capital buffers etc. are sound," he said.
Dear CEO letter
Receipt of such a notice was not regarded by banks as a "pre-enforcement" signal, said the banker, who said he believed the Bank of England was happy to "de-stigmatize" a process it was likely to use more frequently.
Nevertheless, the letter sent by the regulator to banks subject to such notices makes it clear that banks that fall short of requirements will face action: "You should expect us to consider the full range of supervisory responses where we have concerns," it warns.
The Bank of England served notice to the banking sector in October last year that it would increase the use of such notices. In a "Dear CEO" letter to Britain's 40 largest lenders the regulator warned bank bosses that it had uncovered errors in regulatory reporting in the firms it supervised and it told CEOs that as part of its focus on the integrity of regulatory reporting it would make use of Section 166 reports.
The regulator said the Section 166 probes would look at whether returns to regulators had been properly prepared as well as the quality of banks' governance and control.
"We expect firms to submit complete, timely and accurate regulatory returns. These expectations have not changed; the integrity of regulatory reporting is the foundation of effective supervision," said the letter from Sarah Breeden, executive director for U.K. deposit takers supervision, and David Bailey, executive director for international banks supervision.
The letter followed an independent review into the regulators' supervision of The Co-Operative Bank Holdings Ltd., which revealed a £1.5 billion black hole due to bad loans in 2013. The review recommended more use be made of skilled persons inquiries.
A month after the letter was published the regulator fined Citigroup Inc. a record £44 million for "serious" reporting failures including inadequate internal controls and governance arrangements that led to regulators having insufficient information about the financial health of the bank. Citi had consistently overstated its capital and liquidity ratios over a four and half year period. The regulator said Citi would have been fined £62.7 million if it had not settled.
Both the Financial Conduct Authority and the Bank of England are also still investigating Metro Bank PLC, which regulators found a year ago had applied the wrong risk weightings to around a tenth of its £14.5 billion loan book. The bank initially claimed it had discovered the error itself before admitting after questioning by a newspaper that the regulator had been responsible.
Metro's share price has fallen 88% over the past year and its chairman Vernon Hill has stepped down along with CEO Craig Donaldson.