Professional and Ethical Standards in Banking · Some initiatives emerging from UK banking reviews/...

Professional and Ethical Standards in Banking:

The Relevance of the Scholarly Literature to Practitioner and Policy Initiatives

Loughborough, May 21st 2016

Alistair Milne (Loughborough University)

Andy Mullineux (University of Birmingham)

A provocative thought

“… the banking world is intellectually incapable of understanding its own problems.”

from the introduction to John Maynard Keynes: A Tract on Monetary Reform, 1923

o This presentation will argue that the current efforts to improve standards of behaviour in UK banking lack adequate intellectual foundations

o It concludes that industry and policy makers & the world of scholarship and research need to engage more effectively, in order to to achieve effective practical results in improving the ethics and culture of the industry.

Friday, 20 May 2016 2

UK Banking Reviews (not all ) • Walker Review of the Corporate Governance of Banks (November 2009)

• Future of Banking Commission

• Independent Banking Commission

• Parliamentary Commission on Banking Standards

• The Lambert Banking Standards Review

• The Fair and Effective Markets Review

• Salz Review into Barclays

• The report of the Ecumenical Council for Corporate Responsibility (ECCR)

• The FSA's report into the failure of RBS

• The PRA/ FCA report in the failure of HBOS and Green QC Report on Enforcement (November 2015)

• Competition and Markets Authority Review (in progress) Friday, 20 May 2016 3

Scholarly literature

• Many books and articles on business ethics and culture

• A more modest body of work devoted to ethics/culture in finance o Some exceptions e.g. Amartya Sen (1993) ; Cowton (2002); work on Islamic finance,

alternative institutional forms; the political economy of regulation o Ethics, culture and finance attracting much more attention since the financial crisis see Boatright (2014 3rd ed.); Boatright ed. (2010); De Bruin (2016); Vines and Morris eds. (2014), Denbinski (2016 forthcoming) as well as many journal articles

• Contributions from many disciplines o Finance/ Economics o Law o Psychology/ Behavioural Economics o Sociology/ Organisational Behaviour o Philosophy/ Theology o Political science


Agenda for this session

• Summarise the work from various policy and industry reports o Focus on the major practical challenges

• Draw some perspectives and contributions derived from the literature

Whet the appetite for the two days that follow !

Provide a framework for a potential book publication


Part One: The Challenges There is still great dissatisfaction with banks. A consensus has now emerged that improving culture/ standards is seen as essential to achieving ‘better banking’


Some initiatives emerging from UK banking reviews/ broad concerns about culture and ethics • The major UK banks have initiated processes of culture and governance change

• But the FCA dropped its proposed review of banking culture change in 2015 following the departure of its Chief Executive, Martin Wheatley

• Banking Standards Board and FICC Markets Standard Board established o http://www.bankingstandardsboard.org.uk/ and http://www.fmsb.com/

• Senior Managers and Certification Regime established o The recommendation by the Parliamentary Commission on Banking Standards (PCBS) was for banks, but

extended to all regulated financial firms in March 2016 ꟷ The Senior Managers Regime for persons performing senior roles in a firm (known as Senior Management Functions - SMFs) as

specified in rules made by the PRA and FCA. statutory duty of responsibility (proposed “reverse burden of proof” dropped)

ꟷ Certification Regime will apply to individuals not carrying out SMFs, but whose roles have been deemed capable of causing significant harm to the firm or its customers by the regulators.

• A variety of other PRA/FCA/CMA initiatives on competition, irresponsible and predatory lending, financial inclusion and (il)literacy, remuneration, whistleblowing etc

• Findings of the (Birmingham and Warwick) AHRC ‘FinCris’ Project on Responsibilities for the Financial Crisis (www.fincris.net)


http://www.bankingstandardsboard.org.uk/

http://www.fmsb.com/

From HM Treasury (2015)


A troubling survey by Tenbrunsel and Thomas (University of Notre Dame, May 2015) Email survey sent to financial services professionals with 925 respondents in US, 298 in the UK between Dec 22nd 2014 and Jan 23rd 2015

• 23% of respondents believe it is likely that colleagues have engaged in illegal or unethical activity o while 25% admitted they would use non-public information for a $10milllion profit is there was not chance of being caught.

• 27% of respondents disagree that financial services industry puts the best interest of clients first o 47% find it likely that competitors have engaged in illegal or unethical activity.

• One in ten respondents (one in four earning more than $500,000) has been asked to sign a confidentiality agreement that would prohibit reporting whistleblowing to the authorities.

o 37% of US respondents unaware of the US whistleblowing program (which offers monetary rewards).

• 16% overall (21% in the UK, 28% of those earning more than $500,000) report that their firms confidentiality policies and procedures prohibit whistleblowing of potential illegal or unethical activities;

o 17% of respondents think it unlikely that senior management would report a transgression and a slightly higher percentage fearing retaliation if they were to receive a report of such wrongdoing.

• 39% think enforcement and regulatory authorities are ineffective in detecting investigating and prosecuting securities violations

• SEE ALSO ‘Culture change not getting through to customers’, Discussion Paper by the Financial Services Consumer Council (www.fs-cp.org.uk)


Other voices…

• Other approaches to banking o Alternative institutional forms

ꟷ Mutuals (Co-operatives, building societies, credit unions) and microfinance institutions, including community finance intitutions.

ꟷ They have no clear and unambiguous governance advantages (Llewlleyn)

ꟷ But culture and risk appetite differs greatly and diversity may enhance systemic stability and access to finance

o Banks built on religious or ethical principles ꟷ Examples of ethical banks include Triodos (and the Co-operative Bank!)

ꟷ Much attention to Islamic finance ( particularly as an alternative to debt financing)

• Radical critiques include: ‘Financialisation’; Finance and Politics nexus in the ‘Establishment’ (‘revolving door’ and ‘descending to heaven’)


… Promoting diversity • The Future of Mutual Banking

o Most mutual banks have done fairly well ꟷ Demutualised mortgage banks failed as a result of the financial crisis

ꟷ A number of smaller Building Societies (Derbyshire, Cheshire, Barnsley, Scarborough, Dunfermline) were merged with stronger ones (Yorkshire and Nationwide)

ꟷ The Co-operative Bank failed after Britannia Building Society takeover. In 2009 to form a ‘super mutual’!

o Financial Partnerships worked well due to ‘skin in the game’ ꟷ But gave way to public companies (with changed incentives/potential conflicts of interest)

o Solutions? ꟷ Could the internet be used to rebuild mutualised local community banking?

ꟷ Can partnerships be rebuilt (or simulated) in investment banking?

• Restoring relationships / customer orientation o Handelsbanken (for SMEs) and some ‘Challenger Banks’ (e.g. Metro)

• Are there prospects for establishing UK community banks? o Like the German Sparkassen-the Hampshire and Bournemouth municipal banks


Part Two: Scholarly Perspectives and Contributions The goal – better culture and ethics – is clear, but is it achievable and if so how? Five insights from the research community that could be critical to achieving desired outcomes


Biting the (BoE) hand that is feeding us… • Box 24 of the Fair and Effective Markets Review asks for further theoretical

and empirical academic research on the following: o Role of biases and organisational culture in shaping conduct and risk management. o Affect of compensation and remuneration on systemic and conduct risk within

financial firms. o How do changes in structure affect fairness/effectiveness of FICC markets?

• Narrow: ignores much/ most of the potential contribution of scholarship o Purely economics/ instrumental o Nothing on institutional, legal dimensions or the purpose of banking o Limited on technological change (what is the role of policy makers?)

• We would suggest the following… o There will be no return to “normal” o Appetite for continuing evolution of the industry is a political necessity

ꟷ We need regulators, bankers and scholars to think ahead on what that will be ꟷ Banks need to be involved in this discussion, even if only to discuss and communicate the

purpose of banking and the limitations of radical reform


1. Purpose of banks • Are they different from other firms? How?

o Is it appropriate that they operate (mostly) under standard corporate form and with the same accounting standards as non-financials

• A questionable claim: banks as risk takers o “We need banks taking risk to promote investment/ support markets, so we must

not excessively inhibit bank risk-taking” o e.g. Jerry Grimstone at FT/ BSB conference in March

ꟷ A view drawn from culture of trading ꟷ Unclear, is the purpose of risk taking market making or position taking?

• Alternative purposes o Safekeepers o platforms for completing transactions (payments, lending/ credit provision, market

purchases/ sales) ꟷ So their function in this respect is risk management, or more accurately, allocation of risks

o Institutions for supporting clients and customers in the complexities of financial transactions


2. Scholarship on ethical finance

• A large degree of consensus in the literature o It is fairly clear what ethical challenges are and what distinguishes ethical and non-ethical

behaviour o So the challenge is practical, of ensuring behaviour is seen and subject to social sanction, that

individuals understand what they are doing and are aware of the consequences of their actions

• Scholarship has made a start on a typology of ethical challenges in finance o Fiduciary responsibilities (in investment but also banking) o Advice on financial decisions o Dealing with financial distress o Market making & conflicts of interest

Ensuring these and other basic situations are clearly understood

• University researchers and teachers have a role to play developing high quality materials for training in professional ethics


3. The role of standards

• What are standards? There is a literature !

• “Agreed ways of doing or making things” (Houstoun, Milne and Parboteeh, 2015).

o We were writing about technical standards. But are ethical, cultural or behavioural standards really different?

o Well established approaches to behaviour standards in ISO (ISO 9000 quality standards, ISO26000 social responsility standards etc.)

ꟷ Will the BSB help the industry develop a standards statement in this style?

• See De Bruin (2016) – competence rather than ethical understanding is key

• Suggests that standards/ competences must be agreed and demonstrated


4. Effective promotion of desired behaviour and culture? • A large literature on many industries

• Would seem to require peer review and/or metrics o Peer review (not necessarily published) o Qualitative comparisons across firms and over time

ꟷ Excellent New City Agenda/ Cass report of 2014 But for full value needs to be repeated over time

o Quantitative metrics (takes time get these right)

• External governance, yes; but examine the track record for large public companies, across all industries, not good

• Related question, an impression: established banks are suspicious of standardisation and transparency. e.g. resist

o comparative metrics e.g. on fraud and account losses o simplicity and standardisation for customer product and service comparisons

Why? o Will they embrace shift to role as information platforms e.g. APIs (cf current CMA inquiry)?


5. Culture and ethics in regulation

• Do regulators do enough to examine and challenge their own culture? o E.g. are decisions on regulations and supervision influence by the need to

protect themselves in the event of anything going wrong? ꟷ Insufficient attention to the overall outcome

• Do regulators have sufficient regard to wider responsibilities o E.g. for shaping the structure of markets .e.g through technical standards, to

achieve better outcomes?

o Are they sufficiently alert to possibility that the world changes e.g. 1980-2007 was not normal?

• Do regulators encourage confrontation -> defensive culture in banks?


Concluding slide We avoid pat conclusions – though we hope some conclusions will emerge from our two days of discussions. We do though emphasise the need for engagement between the worlds of practice and the worlds of scholarship in the challenge of achieving better banking.

Thoughts / questions?


Professional and Ethical Standards in Banking · Some initiatives emerging from UK banking reviews/...

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