Oct
2015
Ethical
Banking
A Primer
Why banks must put social purpose at the heart of their strategies
A white paper by
Jens van ’t Klooster
and Marco Meyer
03
Table of
Contents
Executive Summary
About the report
04
05
1
1.1
The Problem With Banks
Social cost of a large banking sector
06
07
2
Ethical Banking: The key concepts
08
3
3.1
3.1.1
3.1.2
3.2
3.3
3.3.1
Ethical Banking: Putting it into practice
Trust: Focus on building trustworthiness
What is trust?
From trust to trustworthiness
Getting the culture right
Social Purpose: Myths and truths
Identifying banks’ social purpose
09
09
09
10
11
12
13
4
Teasing out the answer:
An ethical strategy in practice
14
5
Conclusion
15
www.jbs.cam.ac.uk/execed
Ethical banking
04
Executive
Summary
a primer
The societal role of banks has become hotly debated in the wake
of the global financial crisis (GFC) and a string of scandals over
bankers’ behaviour. Members of the public, academic researchers
and financial regulators have become more critical of the role of
banks in society and have challenged some of the assumptions
about the positive role banks play in society.
Economists and scholars of finance have cast doubt on the idea
that more finance is better for the economy. Not only do
economists see the banking sector posing significant risks to
society1, they also question whether the expansion of financial
services is indeed always socially useful, with some suggesting
the UK finance sector is significantly larger than it should be to
serve the real economy2.
Banks are under pressure to respond to those criticisms when
they set out their corporate strategies. Traditionally, developing a
corporate strategy involves setting out the overall goals of the
corporation, as well as policies and plans to achieve these goals.
Strategic goals commonly include growing profits or market
share, expanding the value chain, or entering a new market.
Banks need to broaden their strategic thinking to include ethical
goals. The corporate strategies of banks needs to be ethical
strategies as well. An ethical strategy should:
— formulate the social purpose a firm aims to serve
— minimise the harms inflicted and operational risks
imposed by the firm on society
— set out a plan of how the activities of the firm contribute to
achieving its social purpose.
So far banks have tended to merely react to ethical debates taking
place around them. If ethical issues are discussed at the strategic
level at all, they are usually voiced in the language of “legal and
conduct risk” or regarded as a cost of doing business. This paper
provides a primer to the research paper Ethical Banking: The Key
Concepts that discusses the concepts of trust, organisational
culture and social purpose in more detail.
1
Reinhart, Carmen M., and Kenneth S. Rogoff. 2009. ‘This Time Is Different: Eight Centuries of Financial Folly.’
Princeton, NJ: Princeton Univ. Press.
2
Arcand, Jean-Louis, Enrico Berkes and Ugo Panizza. 2012. ‘Too Much Finance?’ IMF Working Paper 12/161.
Washington, D.C.: International Monetary Fund.; Cecchetti, Stephen and Enisse Kharroubi. 2012. ‘Reassessing the
Impact of Finance on Growth.’ BIS Working Papers No. 381. Basel; Law, Siong Hook and Nirvikar Singh. 2014. ‘Does
Too Much Finance Harm Economic Growth?’ Journal of Banking & Finance 41 (April): 36–44.
05
About the
report
Jens van ’t Klooster and Marco Meyer are PhD researchers at the
Faculty of Philosophy of the University of Cambridge and
members of the Cambridge-Groningen Trusting Banks research
group of Professors Alex Oliver and Boudewijn de Bruin.
Jens received an MA in Philosophy from the Free University of
Berlin, and a BA in Philosophy and a BSc in Psychology from the
University of Amsterdam. His dissertation will be on central
banking and political legitimacy.
Marco received a Master’s degree in philosophy from Oxford
University, and a BA degree in Philosophy & Economics and a BA
in European History from Bayreuth University. He has worked for
the consultancy firm Principia Advisory on improving
organisational ethics in a large global bank.
The longer research paper entitled Ethical Banking: The Key
Concepts that forms the basis for this paper was written for the
Cambridge Judge Business School’s Centre for Compliance &
Trust and is published as a working paper. The research is part of
the Centre’s wider efforts to explore the interface between values,
behaviours and compliance within the financial services
industry.
The full research paper can be found at http://www.jbs.cam.ac.uk/
researchpaper-ethicalbanking.pdf. For any comments or
questions regarding the paper and other issues related to ethical
banking, the authors can be reached on [email protected] and
[email protected].
www.jbs.cam.ac.uk/execed
Ethical banking
06
1
The
Problem
With
Banks
a primer
It is by now a cliché to say the global financial crisis (GFC) has
undermined trust in the financial services, but the figures are
striking. In a survey conducted in the UK, 73% of respondents
described the reputation of banking as bad and only 4% believed
that banks observed high ethical standards, putting banking on a
par with betting and online gambling3. The same survey showed
that only 17% of respondents trusted bankers to tell the truth.
In recently conducted surveys on trust more generally, finance
turns out to be the least trusted industry4. Yet just nine years ago
banks were seen as one of the most trusted industries in the US,
alongside biotech and life sciences5.
The events of the GFC have led academics and politicians to look
more critically into the social role of finance.
Increasingly, worries about the social costs of a large banking
sector colour the public debate. Regulators have also become
increasingly hostile to financial misconduct. Global banks have
paid more than $160bn (£105bn) in fines and legal settlements
with US regulators alone since the financial crisis6. In the last
five years alone, the five largest UK banks have paid more
than £40bn – 60% of their earnings – for legal costs related to
litigation, regulation and customer redress. Calls for stricter
banking regulation have not abated with the third Basel accord.
Historically, views on the wider benefits of financial markets
have shifted a number of times. Extensive discussions on the
danger of financial instability can be seen the early decades of
the 19th century and the period between the two World Wars.
Such periods only ended with new and tighter regulation. The
regulatory changes currently underway may be just the start
of a similar transformation of the industry. Ethical banking
allows banks to anticipate such changes and contribute to
these historical developments in a positive way, rather than
simply being forced to comply with them. In the coming years,
formulating a corporate strategy that gives pride of place to social
purpose will be the most important challenge that banks face.
3
YouGov-Cambridge. 2013. ‘Public Trust in Banking.’ YouGov-Cambridge. http://cdn.yougov.com/cumulus_uploads/
document/ylf7gpof19/Public_Trust_in_Banking_Final.pdf.
4
Edelman. 2015. ‘Edelman Trust Barometer 2015.’ Edelman. http://www.edelman.com/2015-edelman-trustbarometer/.
5
Edelman. 2006. ‘Edelman Trust Barometer 2006.’ Edelman. https://www.edelman.com/assets/
uploads/2014/01/2006-Trust-Barometer-Global-Results.pdf.
6
Stabe, Martin, and Aaron Stanley. 2015. ‘Bank Fines: Get the Data.’ Financial Times. July 2015. Accessed: 15 Sept.
2015. http://blogs.ft.com/ftdata/2015/07/22/bank-fines-data/.
07
1.1 —
Social cost of a large
banking sector
An important reason to think that current debates will not simply
disappear is the scale of the social costs associated with a large
banking sector. We review these costs to bring out the fact that
banks need to do more to justify their operations:
— Financial crises. During the 2008/09 GFC, UK taxpayers paid
£133bn in compensation to depositors of insolvent banks and to
rescue Royal Bank of Scotland (RBS) and Lloyds Bank. The UK
Treasury also provided guarantees for a total of £1.02tr. The
direct costs of banking crises are dwarfed by the slump in growth
accompanying banking crises. Bank of England Chief Economist
Andrew Haldane estimates the cost of the lost growth for the UK
at £1.8tr7.
— Negative effects on growth. Finance increasingly draws on
highly skilled employees, thereby competing for talent with
industry. According to studies, after the size of the banking sector
reaches a certain threshold, it puts a drag on economic growth.
This threshold may be reached at private credit levels of 100%8.
This is clearly an issue in Britain, where domestic credit levels
were at 141% in 2014, down from 192% in 20109.
— Regulation costs. The societal costs of banking regulation and
supervision extend beyond merely hiring more staff. The future
of the financial sector now takes up an important part of public
deliberations. Without a large and complex financial sector,
public policy could focus on other issues.
— Rising social inequality. Countries with a large financial
sector tend to have a more unequal distribution of income. Wages
that financial firms pay to skilled employees are well above those
of employees with similar profiles in other sectors10. Since
expansion of the financial sector leads to increased stock market
capitalisation and wealth in stocks is concentrated in higher
income households, dividends and capital gains go mostly to top
income shares.
7
Haldane, Andrew. 2010. ‘The $100 Billion Question.’ BIS Review 40/2010.
8
Arcand, Jean-Louis, Enrico Berkes and Ugo Panizza. 2012. See note 1.
9
World Bank. 2015. ‘World Development Indicators Online (WDI) Domestic Credit to Private Sector (% of GDP).’
http://data.worldbank.org/indicator/FS.AST.PRVT.GD.ZS.
10
Philippon, Thomas, and Ariell Reshef. 2012. ‘Wages and Human Capital in the U.S. Finance Industry: 1909-2006.’
The Quarterly Journal of Economics 127 (4): 1551–1609; Cournède, Boris, Oliver Denk and Peter Hoeller. 2015.
‘Finance and Inclusive Growth.’ OECD Economic Policy Papers. Paris: Organisation for Economic Co-operation
and Development.
www.jbs.cam.ac.uk/execed
Ethical banking
08
2
Ethical
Banking:
The key
concepts
An ethical strategy spells out what social purpose a bank wishes
to pursue, and how it will shape its activities accordingly. Our
research provides banks with guidance on three key concepts for
developing an ethical strategy: trust, culture and social purpose.
Banks need to restore trust relationships with customers,
regulators and society at large. For this, they need to build an
ethical organisational culture that promotes ethical behaviour
and encourages employees to take moral responsibility. In doing
so, an account of social purpose should provide the overall moral
framework for developing the bank’s ethical strategy. The social
purpose of an organisation is what makes the existence of an
organisation desirable from the perspective of society.
Without an account of social purpose, there is no way of telling
whether a bank has an ethical organisational culture or whether
it is behaving in a trustworthy manner. Accordingly, banks that
lack a conception of social purpose will have difficulties shaping
the culture of their organisation in a way that warrants the trust
of customers and prevents ethical failure.
As the two diagrams below illustrate, having a social purpose can
strengthen the internal culture and external trust in a bank.
When it is absent, the positive flow goes into reverse.
Ethical
Culture
Ethical Culture
Social
Purpose
Criminogenic
Culture
Trustworthiness
Trustworthiness
Ethical Culture
Trust‑
worthiness
Lack of
Social Purpose
Ethical
Failure
a primer
09
3
Ethical
Banking:
Putting
it into
practice
The long research paper – Ethical Banking: The Key Concepts –
provides banks with an extensive introduction to the three key
concepts: trust, culture and social purpose. Despite common
usage, these concepts are often used in a vague and thereby
non-committal – or else specific but unhelpful – way. We
introduce definitions and key distinctions, and we also spell out
how these concepts should be interrelated in formulating an
ethical strategy. These are the main points of our analysis.
3.1 —
Trust: Focus on building
trustworthiness
Banks have drawn the wrong lessons from the sharp falls in
consumers’ trust in them in the wake of the financial crisis. Too
often trust is treated as a resource that can be built up as a
marketing tool, and then employed to the bank’s advantage
where necessary. Instead of focusing on restoring trust, banks
should strive to become more trustworthy. Trustworthiness
requires not just moral motivation, but also competence in
carrying out the task at issue.
3.1.1 —
What is trust?
While having trust in a bank might seem like a straightforward
issue it is very complex. Trust is a three-part relationship
between a trustor, a trustee and an issue at stake. Since trust is a
relation between trusting parties, it is normally tied to the
specific person or entity one has built a trusting relationship
with. Banks deal with a huge number of counterparties, which
differ significantly, such as customers, citizens, other banks and
regulators. Each of these groups is internally very diverse:
customers, for example, comprises of firms, low-income retail
customers and high net-worth individuals. Banks need to
differentiate between these groups, because each will think of
different issues when they decide whether to trust a bank. For
example, as a customer someone may want to trust her bank to
boost the value of her pension fund, notwithstanding systemic
risks that might be generated. As a citizen, the same individual
may care little about the returns generated by the fund, but very
much about the risks imposed by the bank on society at large.
There are not only differences between individuals who place
trust, but also different kinds of trust that need to be
distinguished with more care than is presently done. Basic trust
is grounded in general and commonly available information, or
indeed prejudices, about the kind of person or institution one is
dealing with11. If levels of basic trust are sufficiently high, people
are open to interacting with others and building more demanding
trust relationships. However, building basic trust is particularly
11
Pettit, Philip. 1995. ‘The Cunning of Trust.’ Philosophy & Public Affairs 24 (3): 202–25.
www.jbs.cam.ac.uk/execed
Ethical banking
10
a primer
difficult because of the asymmetry between trust and distrust:
while basic trust can easily turn into basic distrust, it is much
harder to move from basic distrust to basic trust. Basic trust
comes by foot, but leaves by horse.
Critical trust is grounded in knowledge of the competence of the
other person or entity and an ability to monitor performance and
to sanction bad performance12. In the context of retail banking,
the role of critical trust is limited by the narrow understanding of
most retail clients about finance13. Many find it difficult to
evaluate whether they have been treated fairly by their bank, or
whether they were taken advantage of. Without the ability to at
least evaluate whether their trust was abused, clients are not in a
position to become critical trustors.
Finally, goodwill trust is grounded in the trustee’s assumed
goodwill towards the counterparty14. For retail customers, it
would be best if they could trust their banks on the basis of
goodwill. This is because they would have goodwill towards the
bank on the basis that they expect them to behave in a
trustworthy and open-ended way, not just limited to a small
domain of issues, as is the case of critical trust. It appears that
goodwill trust is very common between customers and their
banks – especially the staff at their local branch.
3.1.2 —
From trust to trustworthiness
Rather than attempting to gain trust, banks should ask themselves
what sort of trust they want their customers to have with regard to
specific tasks and products. The lack of financial literacy among
customers and citizens means it is often not realistic for banks to
hope to develop relationships with customers based on critical trust.
Instead banks can and should build critical trust relationships with
regulators and specialised NGOs. Since these organisations often
mediate between banks, customers and citizens, strong and critical
regulatory bodies can have an important role in rebuilding trust.
Being trustworthy in these different ways does not only require a
more ethical motivation, but it also depends on competence. Banks
can only be trusted for doing things that they are able to do
competently15.
12
Hardin, Russell. 2002. ‘Trust and Trustworthiness.’ New York: Russell Sage Foundation.
13
Armstrong, Mark, and John Vickers. 2012. ‘Consumer Protection and Contingent Charges.’ Journal of Economic
Literature 50 (2): 477–93; Lusardi, Annamaria, and Olivia S. Mitchell. 2014. ‘The Economic Importance of Financial
Literacy: Theory and Evidence.’ Journal of Economic Literature 52 (1): 5–44.
14
Baier, Annette. 1986. ‘Trust and Antitrust.’ Ethics 96 (2): 231–60.
15
De Bruin, Boudewijn. 2015. ‘Ethics and the Global Financial Crisis.’ Cambridge: Cambridge University Press.
11
3.2 —
Getting the culture right
Financial regulators have stressed the importance of good culture
in banking. The Financial Stability Board (FSB) has emphasised
the importance of culture for decision making at financial
institutions16. In a speech on the importance of changing the
culture of financial institutions for the better, the President of the
Federal Reserve Bank of New York, William Dudley, argued that
firms must take a comprehensive approach towards improving
their cultures17.
A firm’s or office’s overall environment, rather than individual
characters, influence how individuals act in morally significant
situations. An organisational culture can be seen as ethical or
unethical depending on whether it supports or hinders moral
decision making by employees. For example, if sales personnel
are incentivised to look after the interests of the bank at the
expense of customers, this may ultimately make them insensitive
to the interests of customers.
The longer research paper distinguishes three ways to think
about organisational culture. Intellectualists focus on deepseated assumptions that members of an organisation share. For
them, improving organisational culture requires reducing
inconsistencies between practices and values. Value theorists
focus on shared values and think that the key to organisational
change is improving the values that guide the decisions made by
employees.
We particularly like the perspective of “virtue ethics” that
combines aspects of both. This conception of ethics goes back to
Plato and Aristotle, who made cultivating an excellent character
central to ethical behaviour. According to this theory, people with
a virtuous character will pay attention to all morally relevant
features, even in challenging and new situations, and so act in
morally excellent ways.
16
Financial Stability Board. 2014. ‘Guidance on Supervisory Interaction with Financial Institutions on Risk
Culture.’ http://www.financialstabilityboard.org/wp-content/uploads/140407.pdf.
17
Dudley, William C.. 2014. ‘Enhancing Financial Stability by Improving Culture in the Financial Services
Industry.’ http://www.ny.frb.org/newsevents/speeches/2014/dud141020a.html#footnote3.
18
See note 15 above.
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12
Ethical banking
The virtues of justice, beneficence and courage mean people
react correctly to challenges as they understand them, while
humility, empathy and prudence lead to understanding
challenges in the right way18.
How does this virtue perspective apply to banking? Just because
financial professionals rarely need to risk their lives it does not
mean courage does not apply to them. Courage is require for
them to speak up to a superior, or take responsibility for a
decision others have signed off. An organisation’s culture consists
in shared practices, hierarchies, rules and incentive schemes that
induce members to develop ways of dealing with organisational
problems. These can support employees in exercising their
virtue. For instance, an organisation that aligns decision making,
power and accountability is likely to foster diligence and
responsibility in their employees.
3.3 —
Social Purpose: Myths and truths
Creating an ethical organisational culture and establishing
trustworthiness requires a vision of social purpose. The social
purpose of an organisation is what makes its existence desirable
from the perspective of society.
Most people would immediately identify the social purpose of a
hospital or a school. However, a similar shared understanding of
the social purpose of banks is lacking. Banks impose costs on
society – potentially large costs in the case of a financial crisis, as
highlighted earlier. But the real issue is not just that they impose
costs, just as other industries do, but also that it is not always
clear how finance provides offsetting social benefits. The most
important challenge for ethical banking in coming years is to
identify the social value of financial products – and to increase
this value where needed.
Banks provide a vast array of services targeted at very different
groups of customers. For each of these services, one can ask what
is its social purpose. This is especially important, as we think the
debate is currently impaired by what we describe as “myths”
about the benefits of the banking industry. Chief among these is
the myth of lending for investment that says the main economic
contribution of banks is that their loans allow firms to invest.
While it is undeniable that banks do some direct lending to firms,
this constitutes only a relatively modest part of the total
operations of banks. In fact, the majority of large firms are
currently net creditors. The British Banking Association (BBA)
fails to give an adequate account of the social purpose of banking
when it gives pride of place to £53bn lent out to SMEs in 2014,
while simply ignoring all investment banking activities.
a primer
13
3.3.1 —
Identifying banks’ social purpose
Banks must make having a social purpose their concern, but they
cannot expect to find one single, overarching purpose. Instead
the question of justification arises both for each individual
financial institution, and also for each activity they carry out and
each product they offer. Banks need to justify each of their
activities, not just the most clearly beneficial. As banks look over
the portfolio of products they will offer to customers, they should
ask questions such as:
— What problem does this product solve for the customer?
— How do the benefits weigh up against risks and incurred
costs such as fees for different kinds of customers?
— How much flexibility will the customer have in difficult-toforesee circumstances?
The social purpose of a financial product depends not only on its
benefits for customers, but also on consequences for uninvolved
third parties. Much of the innovation within financial markets is
driven by banks. This gives them an advantage over customers
and regulators in shaping the overall structure of the market.
Rather than using this advantage to maximise short-term income
from sales, banks should use more of their expertise to maximise
social benefits and minimises costs. Banks can reflect on these
issues by asking the following kind of questions:
— What effects will this product have on the market in which it
is introduced?
— How does the product affect contractual obligations between
the customer and uninvolved third parties?
— How can the bank co-operate with regulators to make this
product as effective as possible?
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14
4
Teasing
out the
answer:
An ethical
strategy in
practice
Ethical banking
There is little reason to expect the banking sector will find one
single, overarching purpose. Instead, banks should integrate
social purposes into product developments on a case-by-case
basis.
The recent decision by Royal Bank of Scotland (RBS) and NatWest
to discontinue “teaser rates” on their credit cards shows, in an
exemplary way, what ethical banking means on a day-to-day
basis. Credit cards are an increasingly common tool for poorer
households to manage their finances. Eight million Britons –
almost half of low-income households – have no savings at all.
Faced with unexpected and/or irregular costs, borrowing money
is often an important means to addressing immediate problems.
However, more than 60% of households using high-cost credit
are either insolvent or in arrears, compared with only 15% for
other forms of credit. In 2012, more than 5,000 people became
homeless as a result of mortgages or rent debts.
Customers who take out credit cards on teaser rate offers are
disproportionately represented in these troubled groups. These
offers provide customers with interest free purchases or lower
interest rates on balances for an initial period. After this period,
interest rates increase dramatically.
These low rates are profitable for banks because around twothirds of customers do not switch banks by the time the offer
period ends. In particular, less financially literate customers pay
high interest rates, whereas more sophisticated customers tend
to profit from these offers.
In March 2014, RBS and NatWest decided to end teaser rate deals
and offer a single interest rate to all consumers. What was
significant is that the decision exemplifies the three concepts in
our paper: trust, culture and social purpose. Explaining the
decision, Moray McDonald, Interim Head of Products and
Marketing at RBS, said: “We’re hunting through everything we do
across the bank to make sure we are doing the right thing for our
customers. The credit card industry is absolutely dominated by
teaser rates, trapping people into a spiral of debt that they never
pay down. It’s not good for our customers, and it will play no
future part in this bank. Removing these teaser rate debt traps
and launching a new transparent, low rate credit cards will be a
big step towards earning back our customers’ trust.”
The approach of RBS and NatWest shows how to implement an
ethical strategy. It places benefits to customers above the
question of what customers consent to; it considers the effects of
teaser rates on the market into which they are introduced; and
supports regulators by providing an alternative approach.
Regulators should be supportive of RBS and NatWest and create a
business environment where ethical decisions put banks at an
advantage to competitors.
a primer
15
Conclusion
Seven years after the last global financial
crisis, it is clear that banks still face several
deep-running ethical issues and a crisis of
trust. Rather than patching up problems
one by one as they become apparent,
banks should integrate ethics into their
corporate strategy.
Banks can improve their current standing
in society and regain the role that they
were seen to play before the financial crisis
by reflecting on the role of trust,
organisational culture and, above all,
social purpose in their corporate
strategies. Any attempt to regain trust and
define a target culture is inextricably
bound up with the question of the social
purpose of banks.
The proposals outlined here are discussed
in greater detail in our longer research
paper Ethical Banking: The Key Concepts,
which also contains a detailed explanation
of the philosophical concepts that
underpin it. We do not provide readymade answers on how to develop an
ethical strategy, but seek to provide banks
with the concepts they need to develop
one. Banks should themselves find out
how their activities are adding social value
product-by-product and service-byservice. We hope that our work will help
banks to rethink what banking is really
about. The transformation that banks will
go through in the years to come will in part
be an ethical transformation, which needs
to be negotiated in ethical terms.
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