HSBC: A Bank in Good Company

In July, a United States Senate report claimed that HSBC (NYSE:HBC) allowed clients to shift potentially illicit funds from countries like Mexico, Iran, the Cayman, Islands, Saudi Arabia, and Syria. Now, the bank is feeling the full extent of the investigation.

According to a 355-page U.S. government report released on Monday, HSBC was used by Mexican cartels to transfer funds back into the United States, by Iranians to circumvent U.S. government sanctions, and by Saudi Arabian banks that had ties to terrorists. Furthermore, the report states, executives at HSBC and regulators at the Office of the Comptroller of the Currency ignored warning signs, and failed to end the illegal practices on many occasions between 2001 and 2010.

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Since the investigation began, HSBC has set aside $1.1 billion to cover any potential fines for the anti-money laundering violation. However, the fine could cost HSBC more than $1.5 billion and will likely lead to criminal charges. A settlement has not yet been made.

As Reuters reported on Monday, the probe has damaged the London-based bank’s reputation, and its third-quarter results were affected.

“The report undoubtedly caused considerable reputational damage to HSBC,” the bank’s chief executive, Stuart T. Gulliver, told reporters on a conference call on Monday. “The extent to which that has resulted in loss of business is hard to measure, but it has undoubtedly damaged our brand.”

For the third quarter, HSBC reported on Monday that underlying profit grew to $5 billion, an increase from $2.2 billion in the year-ago quarter. In comparison, underlying operating expenses rose by 16 percent year-over-year because of higher regulatory costs, which the bank said amounted to $200 million to $300 million. The third quarter results also included an additional provision of $800 million “in relation to the ongoing US anti-money laundering, Bank Secrecy Act and Office of Foreign Assets Control investigations,” and a $357 million charge for mis-selling payment protection insurance in Britain.

Shares in HSBC fell 1.5 percent in afternoon trading in London after the report was released.

Even before the U.S. investigation began, Gulliver initiated a restructuring plan to streamline the bank’s operations; now, with potential fines looming, the cuts have become all the more important. By the end of next year, he hopes to surpass his target of cutting annual costs by $3.5 billion, but slow revenue growth and higher compliance costs have made hitting the target a challenge.

HSBC is not the only bank faced with regulatory problems. Barclays (NYSE:BCS) agreed to settle charges that the bank tried to manipulate the London interbank offered rate in June, and both the Royal Bank of Scotland (NYSE:BCS) and Lloyds Banking (NYSE:LYG) have set aside funds to reimburse customers who were inappropriately sold insurance products.

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