Top 10 op risk losses of 2017: crisis-era fines abate

Total losses fell by half last year with large fines slowing; frauds take top three slots. Data by ORX News

Industry-wide operational risk losses fell by more than half in 2017, plummeting from $49.8 billion in 2016 to $23.1 billion, thanks to a drop in the number of large fines and settlements meted out by regulators against banks from legacy crisis-era wrongdoing.

The 10 biggest operational risk loss events of 2017 accounted for 45% of all losses, with fraud and misconduct dominating the top 10. Within these two loss classes, a geographical theme emerged: conduct losses were concentrated in North America and Europe, whereas Asia-Pacific and Latin America experienced the most losses from fraud.

The three largest losses this year were frauds. The top spot was occupied by improper transactions at Brazilian bank BNDES totalling 8.1 billion real ($2.52 billion). Brazilian police discovered improper dealing between a BNDES subsidiary and a meat processing company. According to the investigators, the transactions were carried out with no due diligence and without following contractual requirements. Warrants have been issued for 37 people thought to have been involved in the scheme.

Secondly, employees at Shoko Chukin Bank improperly granted ¥265 billion ($2.39 billion) of loans as part of a crisis response programme that offered low-rate financing to small businesses. Similar to other conduct issues that have arisen under pressure from high targets, employees at 97 of Shoko Chukin’s 100 branches were found to have improperly granted the loans by falsifying approval documents in an attempt to meet lending targets that did not align with demand.

In third place, after a long-running investigation the SEC brought charges against the Woodbridge Group of Companies and their owner Robert Shapiro, accusing them of running a $1.22 billion Ponzi scheme from 2012 until it collapsed in December 2017. According to the SEC, Woodbridge convinced 8,400 investors to take part in his scheme. The companies had already been the subject of legal action in eight states since 2015.

At number four is €963 million ($1.18 billion) that Societe Generale agreed to pay to the Libyan Investment Authority, a sovereign wealth fund, in an out-of-court settlement relating to $2.1 billion of trades conducted between the two parties between 2007 and 2009 that resulted in losses for the LIA. The Libyan fund claimed that the French bank had secured the trades on the back of a “fraudulent and corrupt scheme” involving more than $50 million of bribes. Goldman Sachs successfully defended against a similar case by the LIA in 2016.

The ripples of Bernard Madoff’s Ponzi scheme are still being felt in loss number five. In July and September, Thema International Fund, an Irish fund which invested almost all of its assets in Madoff’s scheme, and a number of its affiliates agreed to pay a total of $1.06 billion to Irving H Picard, the scheme’s liquidation trustee. According to Picard, the funds, linked to Austrian banker Sonja Kohn and the Benbassat family of Swiss bankers, provided Madoff with access to funds in Europe as his scheme began to run out of new cashflows in the US.

The sixth biggest lost is another fraud, also involving irregular transactions. Fifteen executives of Catalunya Caixa, a Spanish bank now part of BBVA, were accused in March of causing a loss of €720 million to the bank by conducting irregular real estate transactions between 2000 and 2013. Conflicts of interest were present in at least half of the transactions, including instances of insider trading when executives bought shares in the companies involved only days before the transactions were made.

At number seven was the combined loss of 49.3 billion rupees ($770 million) from eight Indian banks resulting from commercial loans obtained by Vijay Mallya in an alleged fraud that is subject to ongoing criminal investigation in India and the UK. Mallya, the founder of now-defunct Kingfisher Airlines, is undergoing extradition proceedings from the UK to India. Read more about this loss in our September article.

In the eighth biggest loss, Western Union agreed to pay a total of $586 million to the US Department of Justice, Federal Trade Commission, three state attorneys and 49 US states for anti-money laundering breaches and aiding wire fraud. According to the investigations, Western Union failed to prevent its agents from sending hundreds of millions of dollars of money derived from illicit activities to China between 2004 and 2012, in tranches of less than $10,000 to avoid US reporting requirements. This issue continued into 2018, as Western Union was fined $60 million by the New York Department of Financial Services for the same conduct in January 2018.

The penultimate loss is a hangover from the financial crisis. Deutsche Bank agreed to pay €450 million to settle claims it advised Icelandic bank Kaupthing to loan funds to clients to invest in credit-linked notes with a view to lowering the troubled Icelandic bank’s credit default swap spread.

Finally, in June three employees of Beijing Pangu Investment pleaded guilty to using fake documents to illegally obtain 3.2 billion yuan ($497 million) from Agricultural Bank of China. The company belongs to exiled Chinese billionaire Guo Wengui, who is a critic of supposed corruption within the Chinese government.

Legacy losses

Legacy losses were dominated by conduct risk. In January 2017, RBS announced it would provision a further £3.11 billion ($4.3 billion) to cover the ongoing costs of US investigations into residential mortgage-backed securitisations, and both Lloyds and Barclays provisioned an additional £700 million each for compensation relating to mis-sold payment protection insurance. At least there is an end in sight for this issue, with the UK Financial Conduct Authority announcing the final date for PPI claims as August 2019.

Although the top 10 features a number of fraud events, overall, conduct-related events rose to become the most significant source of loss this year, accounting for $10.75 billion of the total. The significance of conduct risk is set to continue in 2018, as European regulators ramp up the introduction of new legislation, including Mifid II. It remains to be seen if losses will fall in North America as a consequence of US president Donald Trump’s push for deregulation.