We all know that it’s an issue, but promises of new “codes of conduct” in investment banking and capital markets will not automatically lead to better behaviour.
Today is the day that the UK’s finance regulator – the Financial Services Authority – is replaced by two new successor policies. This is part of a government response, replicated globally, to focus on enhanced regulation to ensure that another financial crisis doesn’t happen. But poor individual behaviours in a toxic culture was one cause of the crisis, and this remains relatively unaddressed.
Recently, Mark Carney, the incoming Governor of the Bank of England (and member of BSG’s international advisory board), made a speech in which he remarked:
“Virtue cannot be regulated. Even the strongest supervision cannot guarantee good conduct. Essential will be the rediscovery of core values, and ultimately this is a question of individual responsibility…”
Carney specifically linked trust, financial reforms and economic health. This should be of particular notice to the London-based international banking community as the Governor once more has responsibility for financial regulation in the UK.
Following this intervention, Simon Walker, the director-general of the UK’s influential Institute of Directors noted that capitalism was being given a bad name by the activities of the banks:
“They are harming the whole of British business by focusing only on their own short-term self-interest…”
It is now five and a half years since August 2007 when Northern Rock disclosed the liquidity problems which were to lead it to seeking support from the Bank of England within weeks. It was merely the start of a cataclysmic period in banking, a period from which we are still recovering and more pertinently for this article, reacting to.
I worked in banking throughout the crisis, and had an insider’s view of how individual institutions, the industry, and policymakers responded to financial crisis.
From today’s perspective, the problems of a regional British bank seem minor when considering the subsequent near-death experience of the financial system, the huge taxpayer liabilities generated to support it, a parallel recession deeper than any since the 1930s, and a debt crisis in the Eurozone.
Since then regulators and politicians have scrambled to put in a series of reforms and safeguards to address weaknesses in the system in order to minimise the risks of future bank failure, and if the worst happens, are better able to handle any problem. In the UK there have been government reports, Parliamentary enquiries, a regulatory restructuring, and increased capital requirements. Even how banks structure themselves has been addressed.
However a continuing theme since 2007 has been the serious problems of control, management and judgement in the banking sector which emerge on a regular basis to an incredulous and angry public.
Preventing such a destabilising situation happening again is crucial. In the UK, serious intellectual firepower has been trained on improving the balance of the economy, regulation and governance. Yet it is noticeable that nearly all the responses aim to explicitly control the operations of financial institutions, rather than addressing how the managers of those institutions conduct their business.
Even the EU’s recent bonus cap which aims at the individual level won’t do the trick, as it is a blanket measure the effects of which any institution can easily mitigate by a rise in base salaries (as was done in 2010).
While unsuitable regulatory regimes and asymmetric financial incentives within banks were certainly major problems; it was poor business decision-making, from subprime lending to CDOs to unsuitable mergers, which brought down the system. Flawed decisions were made by individuals, decisions which had appeared reasonable within the cultural and ethical norms of finance. That these norms had become disconnected from those of society has been one lesson of the crisis.
The media have focused on colourful narratives to illustrate larger failures. So we’ve consumed stories about the arrogant young financier who sells junk to pension funds, the senior banker who doesn’t even understand his own business, and the hubristic chief executive in front of a Parliamentary committee who simply ‘doesn’t get it’. We are collectively indignant at such behaviour, demanding retribution and reform.
Yet, far from being masters of the universe, banks and bankers now work within a Hobbesian view of the world, where Leviathan in the form of super-regulators and detailed codification aims to restrict their business. But as history shows, even stringent – as opposed to light-touch – regulation hasn’t always succeeded in bringing stability to banking systems.
Furthermore for a country such as the UK, there is a significant economic stake in continuing to host an international finance centre which is not solely about banking, but also comprises a cluster of insurance, fund management, legal, accountancy, trade and other business services. Retributory regulation may have an impact on tax receipts, employment and investment.
This systemic rules-based response is unsurprising but it has limitations. It is much like a country where the only response to rising crime is to impose stricter laws, rather than also address the causes of criminal activity. Surely the best option is to look at both?
Many bankers are appalled by events, they have not deliberately set out to cause problems and feel that they are being vilified for the incompetence and greed of others. Others refuse to accept that there is a problem at their firm, that the problem in banking is only an issue at the large firms. This is a case of pious myopia. Because in an economic cluster such as the City of London, where most individual business trade with and are reliant on banks, everyone is affected by problems with the banks, and the collective reputation of the City is tarnished.
It is my proposition that wider banking and trading culture is not only one cause of the crisis but a major reason why the industry’s reputation continues to crumble. To put it in language which all bankers will understand, the failure to address this cultural issue is bad for business. Individuals may operate under regulation, but it is individuals who seek to legally mitigate those rules, and it is individuals who make bad decisions based upon narrow-view of business (my year-end bonus or promotion rather than my firm’s reputation).
How those individuals conduct themselves and take responsibility for their actions is dependent upon prevalent culture. And we’ve all read enough about some of the practices in banks to know that culture is an issue.
If we don’t address this cultural issue in banking, then we aren’t seriously addressing one of the fundamental causes of failure, we are not rehabilitating the industry, and we run the risk of future seismic shocks.
One answer is to transform banking into a formal profession complete with a code of ethics at its heart, and this is what I’ll deal with in the second and final part of my blog.