Time for an Ethical Rewiring of Banking and Finance
Much has been written about the ethical causes of the latest financial crisis. Now it’s time to learn from it and build the ethical foundations for banking and the financial system to avoid tripping over the same stone.
This was one of the topics raised over two days at IESE´s biennial, 18th International Symposium on Ethics, Business and Society. With a major focus on the need for an ethical rearmament of banking, the symposium also gave centre stage to the areas of transparency in accounting and responsible investment.
Ethics beyond regulation
The banking system was the first topic to be tackled by Domènec Melé, Chairperson of the Symposium and professor in the Department of Business Ethics as well as Chair of Business Ethics at IESE. "Was the collapse of Lehman Brothers really a mere technical fault with no ethical content?" he asked. It would be absurd to think so. There is always an ethical dimension to any human activity, he said. Ethics, as many speakers were to agree, is the "softer" side to the technical collapse of the banking system.
When talking about the stability of the banking system, the topic of competition often arises. Competition can be both good and bad for economic stability. But is competition in banking good for society? Xavier Vives thinks it can be, so long as the necessary regulation is in place. According to the IESE professor of Economics and Financial Management, banks used to be highly regulated but when they were liberalized, adequate regulation should have been put into place at the same time. Regulation, he said, could be a positive force in the realigning of social and private incentives.
Colin Mayer, Peter Moores Professor of Management Studies at the Saïd Business School at the University of Oxford, was one of several speakers who offered an alternative view on the importance of regulation. "It´s not about regulation," he said. "Regulation is ‘all we know’ in terms of ethical control of banks. But compliance departments are just "avoidance departments". The more we regulate, the more we promote instrumental avoidance.
Mayer also expressed frustration with one-size-fits-all models of regulation which disregarded differences in the size and nature of companies. "The European Commission," he believes "is too intent on harmonizing a model." Worse still, he said, the model they have come up with is based on that of the United Kingdom which makes no sense to the wider picture.
The topic of risk, which is closely linked to banking, was also tackled. As Xavier Vives warned, banks take excessive risk because they operate in an opaque sector and so the incentives to do so are high.
Paul H. Dembinski, Director of the Foundation of the Observatoire de la Finance and Professor at the University of Fribourg, Switzerland, said that ethics, and more specifically concern for others, could actually be used to the financial system’s advantage in order to mitigate risk. The financial system is so complex that risk is high. But Professor Dembinski observed that those working in it could reduce the risk factor by being broad-minded and team players. If they do the opposite, and destroy their neighbor, they will destroy the market as a mechanism.
Companies: a conflict of interests
Where companies are concerned, Professor Mayer said the main ethical problem is that firms exist to serve shareholder interests. "The corporation is a veritable Alice in Wonderland but over time it has become a Frankenstein in Transylvania," he said, and this was because it had been captured by many short-term shareholders, owing to the increasingly quick nature of trading and also the trend for dispersed ownership of companies. "The company is in no single person´s interest and so management runs riot," he said. We need to promote the interests of all stakeholders and to address conflict within stakeholders he said, adding that firms we can trust, so called "trust firms", tended to be those with long-standing shareholders, such as the Nordic firms.
In his presentation, Josep Maria Rosanas, IESE Professor of Accounting and Control, showed that taking shareholder value as the objective of the firm is an inversion of values: profit (or value) maximization is considered to be "good" because with the usual assumptions of microeconomics it is a sufficient condition for economic efficiency. But if the usual assumptions don’t hold (and they typically don’t), then profit or value maximization is a guarantee of nothing: in fact, it may lead to many people being hurt, and therefore to not being efficient. In contrast, the idea of mission, as an attempt to satisfy the real needs of customers (external mission) and employees (internal mission), typically leads to good results both for the firm and for society. Thus, in that context, ethics follow "almost" automatically.
Indeed, John R. Boatright, Professor of Business Ethics at Loyola University of Chicago, made an even bolder claim about mission-driven organisations, saying that, with the right attention they were as capable as not-for-profit companies of incorporating social benefits into their business model.
Oriol Amat, Professor of Accounting at the Universitat Pompeu Fabra and Member of the Spanish National Securities Market Commission, exposed some of the legal and illegal practices in the manipulation of company accounts and the financial and ethical implications behind lying – or not. When companies are in financial trouble, they do everything they can to prevent a sudden drop in share price. They may lie, or bend the truth, in order to present a stable financial performance. However, there is some research suggesting that if they owned up to the facts and took appropriate measures, share prices might not be adversely affected.
Turning challenges into solutions
Two types of solution to the ethical problem were voiced, applicable across the banking and corporate domains: first, solutions to measure ethical behaviour and second, those that try to foster it.
Senior Fellow at Weissman Center for International Business and University Distinguished Professor of Baruch College at the City University of New York, S. Prakash Sethi, has devised a novel system to compare CSR reports, in order to make the reports more objective and therefore useful. He does not believe that these reports, which companies currently produce on a voluntary basis, should become obligatory. It is the very freedom that companies currently have to show how much better they are than their competition that pushes them in a more ethical direction, he said. Sethi argued that companies would be more ethical if given more, not less, freedom and therefore incentives should be created for their self-governance.
Professor Sethi has created a special scoring methodology which has led to findings such as how finance companies score lowest on all CSR criteria, with the exceptions of philanthropy and the environment, in which they excel.
Not all speakers stressed the importance of a report-based social and ethical measure. Robert B. Atwell, who founded Nicolet National Bank in Wisconsin, USA – a community bank which he defined as a "for profit" co-op – said that the inherent difficulty to measuring social responsibility should be tackled by going back to basics. Regulators need to have a personal understanding of a company and to ascertain whether the company is doing what is it supposed to do.
For Professor Atwell, one of the greatest areas of ethical misconduct in companies is the exploitation of the average Joe by the knowledgeable expert. Mortgage lenders had taken advantage of the one-time buyer’s lack of understanding of the market and such behavior had been at the heart of the financial crisis. To curb it, transparency needs to be encouraged by the Consumer Protection Agency, said Professor Vives.
Several speakers revisited the idea of fostering ethical behavior through leveraging taxation. "Corporation tax is a fantastically effective way of ensuring asset values are promoted by companies," Professor Mayer said of the strategy. Compliant companies would be subsidized and those that didn’t comply would feel the tax burden. "It´s down to the Board of Trustees," said Professor Mayer. "We need to ensure that companies under them uphold traditional values and take responsibility for companies not doing so."
Investing with a responsible conscience
The closing panel discussed how to make finance work for the benefit of society.
Jaume Iglésies, Head of Values Based Investing at UBS AG in Zürich, spoke about the motives for the sustainable investment portfolio offered by UBS, the largest wealth manager in the world. Getting their clients to invest in the community is a way of unlocking capital. "If we could get them to spend just 0.1 per cent of our assets, that would amount to 1 trillion euros in a decade," he said. He emphasised how such investments needed to be part of an attractive package for UBS clients, adding: "It’s all very nice to talk about climate change but how do you incorporate that into a portfolio?"
Harry Hummels, Professor of Ethics, Organisations and Society at Maastricht University’s School of Business and Economics, who is also Managing Director of SNS Impact Investing, talked about impact investing, in which capital is placed in businesses, not-for-profit organisations and funds that work to improve society. It provides an opportunity for investors to align their social and financial objectives.
The term "impact investing" should not be brandished about for effect, Professor Hummels cautioned. "[Those claiming to invest in such a way] need a framework to measure the ethical value added." Intentions, financial and other returns are important. Ironically, sometimes it is through fears over their reputation that some, such as pension funds, are involved in impact investing. JP Morgan is a serious player in the field and this year revealed a total of $46 billion in impact investments under management, he said, with a growth rate of 25 per cent yearly.
He admits that there are some serious ethical concerns regarding some areas of impact investing. Indeed these investments are "very prone to unethical sides." Over-indebtedness, excessive interest rates and bad conditions in tea plantations are all negatives realities. But, on the flip side, moral value is added and Medical Credit Fund in Africa is one very positive case.
Professor Hummels stressed the impact the investing sector has needs to be seen to be "moral but not moralistic"; that is to say, open-minded regarding the personal and cultural frame of reference of the people being helped. One unresolved issue was at which end of the chain the responsibility laid; with the investor of the people being helped?
Fabrizio Ferraro, Associate Professor of Strategic Management at IESE, presented his research on how to encourage shareholders to be responsible. His fieldwork study of New York-based value-driven coalition of investors, ICCR, looked at the ways in which it had promoted social change in organisations through private dialogue at firms such as Wal-Mart, Merck and Ford.
He observed that in successful cases, the shareholders had created coalitions inside the firm. Change had happened because ICCR was able to meet with the firm’s management over time. Professor Ferraro pointed out how shareholders are not usually experts on the technicalities of the issues they raise, so they really do have to engage with management.
ICCR is comprised of many faith-based institutions, and this projects a moral voice. However, it was most successful when it could reframe issues in business terms. ICCR’s engagement with Ford is ongoing. Decades-long commitment creates a channel whereby the shareholders, with one foot in the door, can shift their efforts from one ethical issue to the next.