Big Brother Comes to Big Banking

Financial Times is reporting that fraud detection software is becoming more and more a fact of life in big banking,  which comes as little surprise. It only takes one, or a few, ethically challenged or overly ambitious employees to really make a mess of things -- not just for individual banks, but potentially for the economy as a whole. This is good news for investors who have gotten used to looking over their shoulders, waiting for the next rogue trader's shoe to drop.

Nobody will find out
The U.K. just sent Kweku Adoboli, who worked for UBS (NYSE: UBS), to prison for seven years: a 28-year old in charge of a $50 million book of business who took it upon himself to run his own little banking operation in the confines of the Swiss banking giant.  JPMorgan Chase (NYSE: JPM) suffered a $6 billion-plus loss last year when a derivatives bet to the tune of $100 billion made by Bruno Iksil, a trader in its London office, went at first unnoticed, and then terribly wrong. How does a $100 billion trade go unnoticed?

Banks hope that new fraud-detection software might be the answer to that expensive and increasingly relevant question. These sophisticated programs can ferret out phrases such as "off the books," "nobody will find out," and "special fees" from employee emails. And beyond this, the software is also sophisticated enough to sense "uncharacteristic changes in tone and language" from communications as varied as email, SMS, and instant messaging.

The global accounting and consulting firm Ernst & Young has done research on the effects of this potentially game-changing software development, and the company's director of fraud investigation, Rashmi Joshi, told Financial Times: "The language, which is a mix of accounting phrases, personal motivations and attempts to conceal, are very revealing."

 When ripples become waves
And let's not forget one of 2012's biggest fraud stories: the LIBOR scandal. British superbank Barclays (NYSE: BCS-PD) paid a $450 million dollar fine for its part in manipulating the London Interbank Offered Rate: the interest rate banks and financial institutions around the world use as their own starting point, and that affects an estimated $800 trillion in transactions globally.  

Superstar Barclays CEO Bob Diamond lost his job in the LIBOR mess, to boot. And even though there were those who shed no tears over Diamond's departure, the loss of a CEO is a highly disruptive event for any company, bank or otherwise.  If you want to change the CEO, there are better ways to do it than through debilitating scandal.

Keep an eye on them, not so much on me
We've all come to understand that, more and more, big brother really is watching. From the traffic cameras that catch us speeding and mail our citations automatically to the military drone strikes we hear about on a regular basis, high-tech surveillance is becoming harder and harder to escape.

Well-run banks -- which facilitate the smooth flow of currency between business, consumers, and government -- are critical to the functioning of any modern economy. If the individual bank takes a hard enough knock, or if it involves something as economically pervasive as LIBOR, the damage done by rogue traders could potentially ripple out to the economy as a whole. But even if the damage done isn't quite so epic, fraud and rogue trading are hardly a help to share prices. Who wants to invest in a bank that can't police its own people?

So while I may have personal reservations about big brother sticking his nose into my life, I have fewer when it comes to big brother sticking his nose into the life of bankers. 

With the London Whale trading debacle, JPMorgan Chase had a real trial by fire last year, but I believe the bank has emerged stronger. CEO Jamie Dimon, already recognized as one of the best risk managers in the business, spent the better part of last year doubling down on risk and battening down the hatches at the country's biggest bank. And with a P/E of just under 10, JPMorgan Chase is also one of the great banking bargains out there.

Find out more about JPMorgan Chase in The Motley Fool's just-published special report. In it, you'll learn where the key opportunities for JPMorgan Chase lie, where its core growth will come from, the potential business risks, and an in-depth analysis of its leadership team. Click here now for instant access.

 


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