Ethics and Finance

by Sir John Stuttard

The Financial CrisisWhose Fault Was It?

This article was first published in Quantum magazine. In his recent informative play The Power of Yes, the British playwright David Hare is broadly correct when he says that politicians, regulators, economists, and commentators, as well as individual borrowers and bankers, are all to blame for the current financial crisis. His is one of the few voices of common sense and clarity in this debate. Some say that bribery and corruption, money laundering, tax evasion, lack of transparency, inexplicably high bonuses, mindless risktaking, personal greed, andevenglobal capitalism are responsible. But the majority view, encouraged by politicians and the media, is that it is all the fault of the bankers. And, having started from this premise, they have hit upon an equally ill-judged solutiona return to ethics and morals in the financial sector. European Commission President Jos Manuel Baroso has said that we need ethics back in the financial system, while British Prime Minister Gordon Brown has argued that markets need morals. And the G8 has talked of reforms of international economic and financial systems to promote appropriate levels of transparency, strengthening regulatory and supervisory systems, better protecting investors, and strengthening business ethics. There is, as yet, little attempt to define what is meant by strengthening business ethics. But more and more politicians are calling for economic freedom to be balanced by respect for fundamental norms of integrity and propriety and a strengthening of business ethics and investor protection as well as transparency.

The Perils of Attributing the Crisis to Moral Failure

This strategy for preventing a future crisis is confusing and not helpful when seeking to find real remedies for the problems facing the global financial sector. Indeed, there are parallels between what is happening today and the response of the US Congress to the Enron and WorldCom scandals. The resulting SarbanesOxley (2002) legislation focused on the reliability and accuracy of financial information, which meant that the US government failed, at that time, to fix the real problem, which was a serious shortcoming in corporate governance. There is a real danger that the worlds political leaders will make a mistake on a similar scale if they become obsessed with the need to impose global business ethics. It is true that somethough not allbanks were to blame. However, to point the finger at business ethics and other unacceptable practices such as bribery, corruption, and tax evasion misses the point. These last few problems occur mainly in emerging markets. While there are occasional instances in developed markets, the recent financial crisis was caused as much by governments celebrating continuing economic growth which, with hindsight, we know was based on excess liquidity. This massive credit bubble must have been apparent to public sector economists. It was also caused by a catastrophic failure of regulation, particularly in the United States and the United Kingdom. So, in my view, governments in the developed countries were primarily to blame. Not so China or Hong Kong, where stronger regulation prevented the difficulties experienced in the West. When it comes to the banks, one should also bear in mind that it was poor management judgment and poor corporate governance that was responsible for much of the problem, and not business ethics per se. In the United Kingdom major shortcomings stemmed from the banks seemingly paying, albeit with hindsight, too much for acquisitionsfor example, the Royal Bank of Scotlands acquisition of ABN AMRO and Lloyds acquisition of HBOS. In the case of Northern Rock, it was the boards decision to pursue a strategy based on funding activities via the wholesale money market that proved to be too risky.
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This was compounded by the granting of mortgage loans by some banks (which formerly had been prudent building societies) in excess of the value of the property. RBSs strategy to extend business into the riskier areas of credit default swaps and other derivatives, together with reliance on wholesale markets, proved its undoing when one major US bank, Lehman Brothers, was allowed by the US government to fold. As to the issues of alleged corruption and lack of integrity or propriety, there are a few celebrated cases like Bernie Madoff and R. Allen Stanford, but while these affected a few, typically wealthy, individuals, they are not germane to the real issue of the calamitous mismanagement of the market economy.

Where Does Ethics Come In?

Banks have indeed changed over the last 20 years. The bank manager has for the most part been replaced by a sales manager. Investors and stock markets are now driving the performance of bank executives, who have, indeed, been rewarded with large bonuses and golden handshakesfor failure as well as for success. Bank executives have in fact behaved perfectly ethically when seeking to enhance profitability. It is the job of bank boards to act in the interest of their shareholders, and that means maximizing profits. A clear understanding and pursuit of ethical behavior is at the heart of professional training in the City of London. For example, the Institute of Chartered Accountants in England and Wales says that ethical behavior is vital in ensuring public trust in financial reporting and business practices and upholding the reputation of the accountancy profession. This approach is echoed by the Securities & Investment Institute with its leading publication Integrity at Work in Financial Services and its Code of Conduct for practitioners, updated in 2007 with the help of the late Lord Eddie George, former governor of the Bank of England. Other UK professional bodies have a similar approachthe Institute of Financial Planning with its Code of Ethics and Professional Practice; and the Institute of Bankers, now the ifs School of Finance, with its courses which include ethical subjects. Business ethics also forms part of the curriculum at business schools, but perhaps more could be done to include the teaching of ethics in university undergraduate courses dealing with economics, business management, and financial education. As Stephen Green, chairman of HSBC and an ordained minister, says in his book Good Value: Reflections on Money, Morality, and an Uncertain World: As a matter of fact the ethics of the marketplace are almost by definition universal Everyone knows about the importance of truth and honesty for a sustainable business.

But Ethics Are Not Enough

No, the solution to the problems of the financial sector discussed by the G8 is not to place a disproportionate emphasis solely on ethics. By and large bankers score more highly on this measure than politicians. It is about the management of the economy and the regulation and governance of business strategies, risks, and business practicesand these, of course, include remuneration structures. It is for governments to improve their economic management and set up regulatory structures that match the changing demands of the businesses that need to be regulated, while it is for bankers (and bank boards) to establish strategies and to manage risks as well as to determine appropriate levels of remuneration. Governments and regulators can of course help in specific areas by giving guidance, or even a dictat, that for example mortgage loans should not exceed a certain percentage of a propertys value. They can also advise that executive employment should be for fixed periods of one year only. They can also give guidance that bonuses should be for long-term performance, retractable for poor performance, and insist they are made in equities not cash. There is a desperate need to improve corporate governance across the world because practices are as varied as those of national regulators. Governments, regulators, and businesses need to develop and implement global standards of best practice. But, so far as ethics are concerned, the onus has to be on banks to devise practices that governments, regulators, and the public find acceptable, if not attractive. Stephen Green can have the final say. As the chairman of, arguably, the worlds most successful corporate and retail global bank, our self-questioning
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banker puts it in a nutshell: Any business which values its brand has to be able to ask and give a satisfactory answer to the question: how does the business contribute to the common good?

See Also
Best Practice Best Practices in Corporate Social Responsibility Business Ethics Ethical Funds and Socially Responsible Investment: An Overview Viewpoints Days of Reckoning Lessons from the Credit Crisis: Governing Financial Institutions The Morals of MoneyHow to Build a Sustainable Economy and Financial Sector Regulation, Corporate Governance, and Boardroom Performance Must Be Shaken Up If We Are to Avoid Another Financial Crisis Finance Library Good Value: Reflections on Money, Morality, and an Uncertain World

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