Shock Waves Rock Financial Community : Bank’s Near-Collapse May Put an End to Britain’s Clubby Regulation
With nearly two centuries of success behind it, the Johnson Matthey Group was the kind of company whose pedigree alone inspired confidence. Its presence added to the sense of reliability and permanence that helps set “the City,” as London’s financial district is called, apart from other world business centers.
That anything might be amiss with the group’s banking and bullion-trading arm was, well, unthinkable.
So when the news broke last year that Johnson Matthey Bankers had piled up the equivalent of $345 million in bad debts and tottered on the brink of collapse, even the most cynical voices in the City found it hard to believe.
That the bank nearly went bust because of what British Treasury Secretary Nigel Lawson called an “appalling and bizarre record of incompetence and mismanagement” set off a series of shock waves that, nearly a year later, continue to reverberate through the City, spreading ill-will and adding strength to the winds of change sweeping through the world’s most tradition-bound financial capital.
The near-collapse has brought a flurry of lawsuits involving Lawson, the Bank of England--Britain’s equivalent of the U.S. Federal Reserve--and one of the City’s big-name accounting companies, Arthur Young McClelland Moores & Co. It has dented the mystique of the Bank of England, an institution that has traditionally relied on its prestige rather than law to keep order in the City, triggered unprecedented calls for the resignation of its governor, Robin Leigh-Pemberton, and brought on a police investigation into possible fraud at Johnson Matthey Bankers.
May Become Watershed
Of far greater long-term significance, however, is that many of those who follow events in London’s financial district now believe that the scandal may well turn out to be a watershed in the City’s history. It may turn out to have helped bring about the eclipse of the old-fashioned business values that had survived here, in many cases serving as the primary, binding force in financial transactions.
“The changes it has set in motion may well mark the end of the gentlemanly codes by which the Bank of England and the City have abided for decades, founded on trust and frankness,” the Financial Times commented this summer. “The tradition of mutual respect and confidence had never failed the bank (of England) before. But now it has.”
The growing complexity of banking in recent years has gradually forced something of a regulatory structure on the City, including, six years ago, the first-ever banking legislation. The near-failure of Johnson Matthey Bankers is certain to accelerate change.
“The JMB affair is proof that the time for informal control of banking has passed,” said Oonagh McDonald, a member of Parliament and spokeswoman on economic affairs for the opposition Labor Party. “We are living in a different era.”
How such a prestigious institution as Johnson Matthey became embroiled in such a debacle and whether it was led there by criminal cunning or drifted there because of blind incompetence is something Scotland Yard’s fraud squad is still trying to sort out.
Johnson Matthey established its banking subsidiary only in 1965, to assist with its gold and silver bullion business. The group’s heavy engineering, chemicals and jewelry businesses also used the banking arm. However, as one of the select few institutions that help to set the price of gold on the London market each morning, Johnson Matthey Bankers was most involved in the field of precious metals.
Bank Branched Out
In 1981, with heavy industry slipping into recession and the precious metals markets quiet, the bank began looking elsewhere. It branched into soft commodities and insurance brokering, and expanded its non-bullion loan portfolio.
Growth in loans was particularly dramatic, to more than $420 million last year from $47 million four years before. Profits also jumped to $34 million in 1983 from $16.3 million in 1981.
“The diversification looked liked good business,” recalled a stockbroker, who asked that he not be identified because of his indirect links with the company. “The stock was highly rated and popular.”
To achieve such dramatic expansion in time of recession, Johnson Matthey Bankers took on high-risk customers, many of whom had been refused loans by other major banks. They also charged these clients steeply higher rates of interest.
Many of the loans went to fast-moving merchants dealing with large volumes of commodities, often in politically volatile Third World countries. At one point, the bank’s exposure to business with Nigeria, a country that recently experienced its second military coup in two years, amounted to $170 million, more than the bank’s net worth.
The Bank of England, which routinely reviews quarterly accounts submitted by commercial banks, began asking questions in the second half of 1983 about some of Johnson Matthey Bankers’ loans. In line with Britain’s informal supervisory system, it accepted on trust Johnson Matthey’s assurances that all was under control.
Others who might have sensed trouble did not.
Banking analysts in London’s big investment brokerage houses viewed the bank as a small offshoot of a large industrial conglomerate and spent little time looking at its affairs, while analysts who followed the parent company as a heavy industrials and precious metals conglomerate seemed to be unconcerned so long as the bank was profitable.
Didn’t File Reports
In March of last year, Johnson Matthey Bankers failed to submit its quarterly accounts to the Bank of England. In what Bank of England officials now admit was a mistake, they waited patiently, deciding to review both the first- and second-quarter statements in June. The information in those statements led to audits that unveiled the disaster about to unfold.
While good banking principles counsel against lending more than 10% of net worth even to safe corporate customers, Johnson Matthey Bankers found itself with 120% of its capital extended to just two clients. The amount of loans in danger of default came to 2 1/2 times the bank’s net worth.
Among the bank’s biggest problem customers were:
- Mahmoud Sipra, a flamboyant, Pakistani-born entrepreneur involved mainly in Middle East shipping and films, who is believed to owe the bank between $70 million and $100 million. A legal battle over nondelivery of a cargo of chemicals and steel ended up in a New York state court last year, where the judge described Sipra’s role as “old fashioned piracy on the high seas” and used the words “overwhelming greed” to describe his actions. Sipra now lives in the United States.
- Amjad and Azal Imam, Pakistani ship operators, related to Sipra by marriage and believed to owe the bank roughly $40 million. Backed by a prominent Persian Gulf family, the brothers’ business reportedly ran into trouble when their mentor landed in financial difficulties.
- Rajendra Sethnia, an Indian businessman whose lucrative sugar and rice export business to Nigeria and the Sudan came unstuck following coups in both countries amid allegations of fraud. With debts estimated at $240 million, Sethnia is believed to be the world’s biggest personal bankrupt. His debts to Johnson Matthey Bankers are estimated at as high as $25 million. He is currently in New Delhi’s Tihar jail, charged with fraud in India.
- Budget Holiday Tours, a low-cost British travel company that went bankrupt last October, stranding about 10,000 British tourists on the continent. This company is said to owe the bank about $1.4 million. Investigations indicate that Johnson Matthey Bankers extended credit to the company despite its large operating losses, a dispute with the income tax authorities, suspect internal loans to company directors and the fact that three other large banks had refused it credit.
- Ravensbury Investments, a British property investment company that borrowed $2.1 million to build a shopping center in South Wales, a center that never materialized. A member of Parliament, Brian Sedgemore, charged recently that fraud was involved in obtaining the loan and that potential witnesses in the case had been threatened with violence.
The extent of the financial disaster at Johnson Matthey Bankers was in part masked by sloppy operating procedures and a virtual absence of controls.
It is now believed that the bank had few restrictions either on who in the loan department could lend money or how much could be lent. Credit checks on potential customers were said to have been carried out only rarely; no records of conversations between bank staff and prospective borrowers were kept; accounting was spotty and, in many cases, there was no security on the loans.
Losses Still Uncertain
The extent of the chaos is measured by the fact that more than a year after its near collapse, the exact amount of the bank’s losses is still uncertain. Nor is it clear how senior managers in the Johnson Matthey Group and the company’s auditors, Arthur Young McClelland Moores, could manage to be oblivious to the unfolding disaster.
But for both it has been a costly mistake. Johnson Matthey, unable to mount its own rescue, sold its bank for a token one pound sterling (then about $1.40) to the Bank of England, absorbing staggering losses of $212 million, while the cumulative value of the group’s stock dropped by $280 million as the price per share plummetted by 70% in a few months.
The cost to the auditors is also considerable but more difficult to quantify. The outcome of a suit lodged against it two months ago by the Bank of England claiming negligence and breach of contract won’t be known for months, if not years. Should it lose in court, the penalties, both in economic terms and to the company’s reputation could be severe.
In an apparent counterattack aimed at protecting its name, the company has taken its own legal action, suing Treasury Secretary Lawson and several television and radio stations for libel in connection with remarks that Lawson made last June raising questions about the accountant’s role in the bank’s slide into chaos.
It marked the first time this century that a British minister has faced libel action.
The Bank of England and its governor Leigh-Pemberton, are also casualties of the affair, severely criticized for failing to spot the crisis sooner, then failing to move more quickly once aware of the first signs of trouble.
Official Feels Blameless
Ian Fraser, the little-known Johnson Matthey Bankers’ director who headed the loan department, apparently feels blameless.
“My conscience is clear,” he told a television interviewer recently, adding that the bankers’ code of secrecy prevented him from making any further comment.
A London stock broker who lunched with Fraser soon after the bank’s crisis became public knowledge said Fraser had yet to grasp the extent of the disaster.
“He said the problem was only with two bad clients, but the rest of the portfolio was in good shape,” the broker recalled. “He claimed anyone could make such a mistake.”
Some argue that Johnson Matthey Bankers, as a relatively small bank, should have been allowed to fail. Indeed, the package required to save it was barely 5% of the $4.5 billion needed to rescue the Continental Illinois Bank last year.
But Bank of England officials believed that the Johnson Matthey name, plus its pivotal role in the London gold market, made its survival imperative. Its failure, they feared, could have triggered a run on the other four gold market price-fixing institutions and undermined confidence in the London gold market and in British banking.
In the year since the dramatic rescue was announced last Oct. 1, the Bank of England has installed new management and a new board of directors--though retaining the Johnson Matthey Bankers name--and hopes to recover up to $40 million of the bad loans, either through rescheduling or by finding adequate security for at least some of them.
The Bank of England’s ultimate goal is to recoup its $140 million contribution by selling the bank back to the private sector, a goal it believes is possible. With loan activities only a small part of Johnson Matthey Bankers’ overall balance sheet and a $2-billion bullion business apparently still basically intact desite the crisis, some prospective buyers have reportedly already come forward.