Mutual Dependence - Banking Culture and Individual Behaviour (Part II)
by Seth Thomas
Posted: 29 Jan 2015
PART II (read Part I here)
Changing banking culture and individual behaviour will be no easy task. However, professionalising banking and instilling a code of ethics is one way of restoring trust in the financial system.
Banking has long regarded itself as a profession rather than a trade, yet other professions, such as law and medicine possess key distinctions. For instance, there is a common academic curriculum and vocational training - including ethics - must be undertaken before permission to practice is granted. Throughout any professional's life, continuing education plays an important role in maintaining standards, and ethics are clearly linked to the work. Most significantly, each profession has a governing body - respectively the Law Society and General Medical Council - which closely regulates standards and the conduct of members.
Some financial services, such as retail banking or investment management, require specific qualifications. However, investment banking and capital markets have no common professional training route beyond standard basic regulatory exams.
A scheme of compulsory professional training should be initiated in banking, to ensure that banker interests - and through them, their firms - matches society's interests. At the core of this training would sit a code of ethics, which would define right and wrong according to accepted social standards, providing guidance on conducting finance responsibly. The code would cover obligations and responsibilities to the individual firm, to the shareholder, to the community, reflecting aspirational standards and behaviours for bankers.
The aim of this would be to equip a banker to think more broadly and over the longer-term about his or her daily business, so minimising mistakes which have been come from narrower and shorter-term perspectives. For example, one important question in banking practice would be: is this a sustainable solution for my client and for the firm? Another might be that innovative financial products must show economic and social utility before adoption. In other words, Harley Street-style ethics would become part of Wall Street culture.
Banks might respond that ethics are already institutionally embedded in their firm; but active ethical-based behaviour and passive compliance with rules is not the same thing. As we learn from sport, it is important to act 'in the spirit of the game'. While individual firms often issue their own codes of conduct and offer annual training programmes, more can be done - a piece of paper with ten bullet-points on it given to new joiner does not mean that an institution is ethically-aware. Banking operates within a culture of compliance with fixed rules and processes within which staffers operate, rather than demanding personal responsibility in behaviour. The financial crisis should have taught us that no system of rules can cover everything; therefore in addition individuals require principles to guide them through complex business situations, and an internal culture which reinforces this.
As part of this ethical framework, behaviour should be linked to employee performance reviews at every management level. Furthermore, within a firm the ultimate ethical responsibility must rest with the CEO and be reviewed regularly at board-level given the important linkage to firm reputation. Allied to this, each public firm would report on ethical standards - and transgressions - to its shareholders in every financial reporting period.
Too onerous? Yet more box-ticking? Or a mechanism to ensure that finance takes seriously its responsibility to its shareholders and society in running an ethically-aware and reputational-sensitive organisation. In other words, ethics should become part of how firms manage their business and are rated on their performance by their shareholders. This view aligns with the BSRC's remit.
None of the above should be taken to dispel the need for other reforms. The crisis had many causes, and the collective response needs many answers. Professional standards of conduct by individuals would be the first rung of a ladder of oversight, which would underpin business-unit working practices, then upwards to enhanced governance, through industry regulation, before reaching systemic macro-prudential supervision.
This is not a call to train a generation of banker boy scouts, but rather to ensure that a revitalised banking profession attains the higher ethical standards which society is entitled to expect. Business history shows that high standards are fundamental to profitable, competitive, and sustainable enterprises which support the overall economy, and so this should appeal to self-interest.
The rise of corporate and social responsibility and its inclusion in mainstream business strategy has taken place because it is seen to add long-term value to a business. For example, in 2008 Lord Woolf carried out a review for British Aerospace of business ethics in the defence industry.
If we are to take a strictly business view from a UK perspective, this is not an issue which would provide anything but a competitive advantage for a financial centre. London as a global business centre would be enhanced if its banks operated with higher ethical standards.
Ethics correlate with business aims: they provide clients and investors with trust in decision-making at their counter-parties; and form part of a firm's reputation which in turn should attract the type of quality employee who takes a broader view. Most importantly, it leads to sustainable financial performance, as an ethical organisation is less likely to lurch from scandal to public criticism to legal settlement.
The latter point may be controversial with sceptics - but to take but one case, it is my suggestion that executives empowered to think ethically and independently, rather than those slavishly focused on the year-end bottom line, or engaged in a group-think bubble would have argued against some of the 'me-too' business strategies adopted in the run-up to the crisis.
These weren't helpless firms caught up in a maelstrom of external factors, such as sub-prime housing and increased savings from China and the Middle East; these were institutions which had seemingly forgotten about their wider and longer-term responsibilities, adopting similar short-term market strategies because the 'other guy was doing it'.
Similarly, groupthink applies to recruitment policies which will shape a new generation of bankers. The case for recruiting a more diverse cross-section of society into finance - another strategy to diminish self-selecting narrowness in decision-making - should also be considered. There feels something wrong with a system which has consistently recruited some of the best and brightest young graduates, supposedly linked pay to performance, and still ends up in a financial crisis. Banking shouldn't be or be seen as a risk-free route to riches - individuals who appear overly hungry to make money, perversely may not be the best people to handle it.
Many bankers have in the past preached about risk versus reward, and how their pay has been set 'by the market'. It is now time for the linkage between risk and reward to become more overt, and pay needs to be more closely linked to long-term (as opposed to year-end) productivity and behaviour. Recent bonus claw-backs for market-abusing traders are a welcome sign.
Sustainability relates to wider stakeholders in finance: employees, investors and the community. It is in the financial industry's direct interests to restore public trust. After all, the public aren't simply taxpayers, or indeed voters; they are the industry's retail customers and the decision-makers at their corporate clients. Behaving well reinforces long-term business sustainability and shareholder returns.
If we are serious about fixing the financial system - and we must be, because we need banks for the success of our economy - restoring public trust and remaining competitive globally, the industry must professionalise itself and address its ethical deficit. And this is why changing individual behaviour has to the centrepiece of changing banking culture.
The new BSRC is fresh and non-aligned. It carries no baggage. It has recruited a chairperson in Dame Colette Bowe who understands the industry but is not beholden to it or burdened by history. The Council is a vehicle which has the potential to act as a professional body across the industry. There should be no 'turf issues' about this in relation to other trade bodies - medicine has a plethora of Royal Colleges, but the General Medical Council regulates all practitioners. Vested interests or past practices should never be arguments against reform.
My suggestion is that it engages with individuals and not just institutions - a bottom-up and top-down approach. If the BSRC remains focused on institutions which will then deal with the misconduct by their own members, it potentially allows two problems to continue. Firstly, those business managers within those institutions might be conflicted by issues relating to misconduct by high revenue-generating employees. Secondly, that employees will regard personal conduct much along the lines of historic compliance, namely they will be passive and seek the path of minimum acquiescence.
The ultimate goal of the BSRC is to raise standards and it needs to do so through changing individual behaviour for the better.
I very much hope that any industry-wide professional body - such as the BSRC has the potential to be - sets guidelines and standards for financial practitioners, oversees ethical training, and undertakes governance for all wholesale bankers and traders. It should work with academia to institute professional training, with firms to devise internal oversight and training systems.
The outcome is to enable bankers to attain professional standards and apply ethics in practical business situations. And of course, it would need to be aligned with the regulatory bodies to ensure that proper deterrents were in place for those who stray from the professional path. This is an approach which has worked for doctors, individuals who often have similar educational backgrounds to investment bankers and traders, but who undergo significant professional training and adhere to strict ethical codes.As the Governor of the Bank of England has noted, there is a problem with the 'whole barrel'. Incrementalism in repairing banking culture and its mutual dependent, individual responsibility is an inadequate response. Good business supports faster change and society demands it.
The opinions expressed in this article are those of the author, and do not necessarily represent the views of St Paul's Institute or St Paul's Cathedral.