What the UK's PPI mis-selling scandal shows is that the source of bank profits requires careful analysis, writes Brian Caplen.

Regulators are obviously concerned about banks when they become loss making. But the smartest regulator of all would be one that studies how banks are making their profits and starts asking questions about any line of business that looks too lucrative. The same is true of a bank’s board.

The UK’s Payment Protection Insurance (PPI) miss-selling scandal, which has resulted in compensation payout and costs of £50bn ($61.25bn), is a prime example.  Falling margins on basic banking products led the banks into selling insurance but the scale of the profits being made should have rung alarm bells.

According to the Financial Times' Lex column, PPI accounted for more than 32% of retail and business bank profits at Barclays between 2001 and 2005. The UK regulator estimates the profits made from premiums sold by banks between 1996 and 2012 was about £21bn. Surely those who monitor banks should have been asking questions about this?

Unfortunately, an analysis of the past makes the opposite case – when money is pouring into banks there is an unwillingness to ask difficult questions. In the run-up to the financial crisis, some global banks were producing returns on equity of more than 20% and banking as an industry was outperforming most others. This should have been a spur for regulators and boards to ask questions about where those profits were coming from, which in turn should have prompted a probing of the subprime mortgage market.

Another example: way back in 1993 a trader called Nick Leeson based in Singapore made 10% of Barings’ profits... The rest, as they say, is history.  

Brian Caplen is the editor of The Banker. Follow him on Twitter @BrianCaplen

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