XAVIER INSTITUTE OF SOCIAL SERVICE

2011

ETHICAL CHALLENGES

FACED BY THE BANKING

INDUSTRY

Arpit R. Arthur FINANCE- 2, Roll No: 59

ETHICAL CHALLENGES FACED BY BANKING INDUSTRY

HISTORY

Historically banks have been viewed solely as financial institutions, which should

concern themselves with all things financial. Morality has not entered the equation. This public

view has allowed banks significant leeway with concern to ethical standards. This is because

they have not been associated with the actions taken by the businesses they lend to. Banks have

also stated that a reason for not mounting the new challenges that sustainability presents is that

such inspection would require interference in the activities of clients. However with changing

social demands, and as more is known about the effects that banks can have through their

lending policies, banks have begun to feel pressure from the general public, NGOs,

governments, and the like to go beyond conventional business management. For example in the

mid 1990s the Cooperative Bank asked 6,000 customers what their thoughts were on ethical

banking; 84% responded that it was a good idea. In fact the cooperative bank was formed in

response to the growing consumer base looking for ethically oriented banks.

An ethical bank, also known as a social, alternative, civic, or sustainable bank, is a bank

concerned with the social and environmental impacts of its investments and loans. Ethical

banks are part of a larger societal movement toward more social and environmental

responsibility in the financial sector. This movement includes: ethical investment, socially

responsible investment, corporate social responsibility, and is also related to such movements as

the fair trade movement, ethical consumerism, boycotting, etc. Ethical banking is a juvenile

sector within this movement. Other areas, such as fair trade, have comprehensive codes and

regulations to which all industries that wish to be certified as fair trade must adhere. Ethical

banking has not developed to this point; because of this it is difficult to create a concrete

definition distinguishing exactly what it is that sets an ethical bank apart from conventional

banks. Ethical banks are regulated by the same authorities as traditional banks and have to

abide by the same rules. While there are differences between ethical banks, they do share a

common set of principles, the most prominent being transparency and social and/or

environmental aims of the projects they finance. Ethical banks sometimes work with narrower

profit margins than traditional ones, and therefore they may have few offices and operate

mostly by phone, Internet, or mail.

Internal vs. external banking ethics

Conventional banks deal with mostly internal ethics, ethical banks add to internal

concerns by applying external ethics.

Internal ethics: processes in banks

Internal ethics are concerned with the well being of employees, employee and customer

satisfaction, benefits, wages, unionization, fair sex and race representation, and the

banks environmental standing. Environmentally the potential combined effect of banks

switching to more environmentally friendly practices (i.e. less paper use, less electrical

use, solar power, energy efficient light bulbs, more conscientious employee travel

policies with concern to commuting and air travel) is huge. However when compared

with many other sectors of the economy banks do not incur the same burden of energy,

water and paper use. Many times such energy efficient changes are not based on moral

concern but on cost efficiency.

External ethics: products of the banks’ relationships/products

External ethics are concerned with the wider ramifications of banks actions. External

ethics looks at the impacts that their business practices, such as who they loan to or

invest in, will have on society and the environment. In applying external ethics, one

looks at how the products of banks can be used unethically, for example how borrowers

use the money that is lent out by the bank.

Ethical Issues facing the Banking Industry.

Financial institutions -including banks of all sorts, credit agencies, private equity

firms, pension funds, insurance companies, and the like- have long been considered by

most people to have no other object in view than the creation of wealth. The

performance of financial institutions is therefore measured solely on the basis of their

capacity to maximize financial assets, that is, it has been measured with evaluation

factors that review only their monetary bottom-line results. How much return do they

get on their investment decisions? How much are they able to maximize the assets in

their custody? How much profit can they derive from the loans and credits they

subscribe, from the bonds they float, from the equity they successfully issue on the

financial markets? Banks are judged by their ability to develop financial instruments

such as complex derivatives and sophisticated credit schemes that help connect the

money of investors with the companies in need of those financial resources in the best

possible way. In pursuing these ends, banks, and financial institutions in general, have

long defended the confidentiality of the information pertinent to their business, be it

data about their clients, the sources and the destinations of the economic resources they

handle, their credit-giving policies and procedures, and many more aspects of the

banking profession that tend to be little transparent and not very communicative about

their way of doing business.

Financial institutions have become very complex and sophisticated in the way they

operate. The products and services they offer tend to be more and more complicated.

The ways they invest resources, the way they design, promote, and implement credit

facilities, all become less evident year after year, and the speed at which they evolve is

ever accelerating. This complexity and sophistication of the industry is in part a

response to the shifting and ever-growing needs of the banks’ clients. Companies in

need of financing, and of financial services, tend to have more and more complex

businesses with complex needs and requirements of capital. Globalization also plays an

important role. Banks’ customers often do not have a localized headquarters but they

operate virtually everywhere in the world. Today, it could be argued, it is more difficult

for banks to know in detail where these customers operate and what exactly they do and

how they run their businesses. Moreover, clients change, merge, get acquired, move in

and out of businesses and markets much more rapidly than in the past. It is not only

banks that change so quickly, but their clients, and their clients’ needs also move and

evolve at a higher speed.

Unfortunately, governments, regulators, and other institutions simply cannot

cope with this rate of evolution in a satisfactory manner. Banks are moving too quickly

for the reaction-time of governments and other organizations. As a consequence, many

important issues are being overlooked by the institutions charged with directing our

societies toward the common good.

Were one to give only a superficial consideration to the financial institutions and

the implications of their actions in the world, one could erroneously conclude that

money is just another commodity being traded. There is a danger that money will be

treated as just another product that makes things possible, as a simple means to

accomplish an end. However, such an approach bears the risk of becoming a highly

inhumane approach when we look it in detail. Money is not just another commodity

being handled. Money, both in the form of credit and in the form of investments, makes

a huge impact on the world. Money is a means, not an end; but, it is a powerful means

to do things and therefore evil use of money can indeed create a considerably negative

impact on our world.

Where money comes from, and the destination it might have (that is, the sources

from which it proceeds and the places where it ends up being used), should not be

treated as “just another business transaction”. Money, in all of its forms, has

implications and consequences. The things we do with money, and the things we allow

to be done with money, are not irrelevant from a moral and an ethical perspective.

Money implies actions, money allows things to happen, money promotes and enacts

changes. Money is a very important, if not the most important fuel for the happenings in

the world. Money helps, money builds, money buys, money creates and acquires, but

money can also destroy, pollute, kill, and support evil. Money should not be considered

simply in terms of the percentage points being generated as a return on an investment

over a period of time. Given that banks are the official intermediaries of money, we

need to look at how they handle money and what they do with it. By facilitating money

to others, financial institutions enact and empower them to do things with it. What

clients end up doing with the money they get from a bank, then, is then not irrelevant

from an ethical viewpoint. This is all the more obvious when we consider that the

money banks handle, is indeed to a large extent, investors’ money, not their own.

To handle money as a commodity with no ethical implications and impact is to

overlook critical moral issues, issues that could in fact be financed, and thus, enacted,

promoted, and effectively created, by the investors’ money. In the end, whose money is

the banks’ money? Who in fact owns the money that financial institutions are investing

and lending? In the end, it is the money of individual investors. It is the money of

pension funds, constituted in turn by the savings, the taxes, the retirement plans of

single individuals like you reading this paper.

Given the fact that money can be used in a wrong way -and it frequently does get

used in such a way- and considering that money is eventually funded to a very large

extent by individual investors, we should ask: is it still morally acceptable that financial

institutions invest and lend money indiscriminately, watching only the bottom-line?

Should bank secrecy and confidentiality never be held to answer for the moral and

ethical implications that money can have in our world? Is it acceptable that

governments and regulators lag behind financial institutions’ questionable way of

doing businesses because “the markets can’t wait”? Can we rightly ignore where our

money is being used, what it is financing, where it is being invested, as long as it

generates a good return in percentage terms? Can banks really justify their arms-length

approach to their investments and financing consequences and impacts on our world as

far as they generate more money?

How banks use money is not irrelevant from a moral and ethical perspective.

Crime, pollution, corruption, violation of human rights, threats to human life,

totalitarian regimes, and all sorts of wrong-doing need and use money every year.

Financial institutions play a key role in the supply and movement of money. In this

essay we intend to draw your attention to the key role the banking industry plays in

that supply chain of money. Moreover, we will call your attention to the fact that it is

your money, which can play a key role in that supply chain and that is not morally or

ethically avoidable anymore to investigate and to actively question how banks are using

that supply chain to channel your money, with financial practices that can be fueling

wrong doing across the world. Let us clarify that, whenever investors’ money is

channeled to evil-investments by financial institutions, it is the bank who is guilty of

this wrong-doing and not the individual investor, unless of course, the individual

investor were aware of the wrong-doing (and if he were just as easily able to invest his

money elsewhere, and if he were a significant enough investor to influence the

company or fund in question). What we attempt here is to call the investors’ attention to

the importance of the potential damage that their money could do when invested in the

wrong destinations.

What are our main concerns?

We have several concerns regarding financial institutions and how they use

money. Banks can channel economic resources in different ways that make money

result in some form of evil-doing. The two main ways in which banks can do this are (a)

by lending money to others, that is, by issuing credit facilities to their clients, these

being customers corporations, governments, individuals, etc., and (b) by actively and

directly investing money, that is, owning shares, be it in the name of others or for

themselves, in companies, projects, or countries, that conduct different forms of wrong-

doing. Owning shares of companies that could be conducting wrong-doing is, of course,

not exclusive to financial institutions; however, the large sums of funds that banks have

available to invest make these investments particularly relevant when we analyze

ethical issues facing banks.

When banks lend money to others, the bank may not be doing wrong by itself; it

is these other entities which might be engaged in wrong-doing. However, this does not

excuse banks from their moral responsibility. Money enables and promotes actions, and

in this sense, banks lending money to evil-doers are facilitating their activities. It is not

valid to argue that a bank is only in the business of financing and lending and that

therefore they carry no ethical responsibility in the wrong-doing. Banks effectively

enact, enable, and promote the realization of actions with their lending of financial

resources. In the lines below we will discuss how banks and financial institutions have

been known to effectively fuel wrong-doing through the issuance of credit facilities to

clients in questionable businesses, and through other actions that range from actively

holding shares of companies with questionable practices, to speculation and other

questionable matters.

1. Usurious practices:

Banking is a business concerned with protecting and growing people’s money. As

such, one of its principal purposes is to generate wealth, in the form of financial returns

for its shareholders. As in any industry, it is understandable and acceptable that banks

try their best to maximize their investments and therefore, it is logical that banks charge

interest rates on the loans and financing activities they offer to their clients. However,

banks that charge excessive interest rates, abusive commissions, or ultra-profitable

credit charges that go beyond reasonable standards for taking an extra benefit from a

specific situation in detriment to their customers, are guilty of usury. Usury may be

defined as demanding significantly more money back from customers than is just and

fair. Financial institutions consistently engaged in usury are accordingly a subject of our

concern. While we do not necessarily endorse bureaucratic regulations which may be

excessively burdensome and counter-productive, we do expect banks to act morally

with respect to lending practices within their organizations which are potentially

usurious. We are concerned that banks are frequently charging excessive rates and

imposing unfair advantages for themselves upon customers. We thus expect banks to

take care to implement policies that prevent wrong-doing in the form of usury and

similar sorts of abusive practices.

Financial institutions are also guilty of some forms of usury when they encourage their

customers, especially individuals, to go into excessive debt by taking irresponsible

credit at too high interest rates. Some credit customers, specially those located in low-

credit penetration communities are frequently being subjected to excessive marketing

and pressure to drive them into credit at advantageous interest rates that go beyond

what is customary in the industry.

2. Speculative banking:

The assets a bank lends and invest should be handled responsibly, even moreover

so, when we consider that the bank is investing and lending money that belongs to

other people, i.e., the individual and institutional investors whose money they manage.

Engaging in excessively speculative investments and irresponsible credit lending

practices is morally unacceptable, and in many cases, not even good business. We

believe bankers and financial professionals should take a responsible approach in all

investment and lending operations with its customers’ money. Even in the case of high-

risk, high-return type of clients, a bank is the ultimate entity making the investment

decisions for the investors, and practices of speculatively investing heavily in too-risky

securities just for the sake of short-term returns should be considered cautiously,

especially given the massive loss of wealth that we have witnessed during the current

financial crisis. The point is that there is always an ethical component involved in these

too-risky investments that is being ignored. This crisis has made evident that investing

in financial securities of questionable value (such as derivatives without the adequate

collateral, sub-prime mortgages, irresponsible adjustable-rate-mortgages, and other

investments that do not undergo the serious due-diligence required) have frequently

resulted in clients’ wealth destruction.

The situation of over-speculative, over-risky banking gets especially complicated

from a moral perspective when we consider that clients seldom receive the necessary,

detailed information to let them know what kind of investments their bankers are

undertaking with their money. Another aspect of concern regarding speculative

banking, which has also been evidenced in this crisis, is the fact that many financial

institutions have been involved in speculative investments resulting in enormous losses

for their customers while their executives continue to receive compensation packages

and bonuses in the millions of dollars. While we understand that the banking

profession has traditionally generated a lot of wealth for its executives, their excessive

bonuses become an ethical concern when their clients’ wealth has been destroyed

precisely because of these forms of speculative investment practices.

3. Financing arms manufacturing and trade:

Many banks are actively financing the military industry around the world. While we

recognize the moral acceptability of a country taking care to defend its population, and

thus investing in arms and weapons, we are concerned with excesses and human rights

violations involved in this activity. We are specifically referring to indiscriminately

destructive, overly-damaging weapons and their manufacturers and distributors. These

usually fall in the category of so-called “cluster munitions” which are highly-

destructive weapons which not only destroy an enemy’s military target, but quite

frequently kill thousands of innocent civilian victims.

Why are cluster munitions so harmful? Cluster-munitions are designed to destroy

large areas, thus their use often results in the destruction of civilian settlements, killing

innocent people. On top of this, cluster-munitions weapons cause damage after the

military attack as they contain many explosive components that did not act at the

moment of the attack but remain active there, and explode afterwards. A potential mine

field is created wherever cluster-munitions have been used and their destructive

potential can last for years hidden under the ground. This information has been

corroborated several times by different organizations around the world, and yet

regulation does not actively prevent the manufacturing of these weapons, and of

course, regulation doesn’t prevent financial institutions from either investing or lending

money to these companies.

4. Financing and supporting totalitarian regimes:

Banks frequently give loans to companies operating in countries governed by

totalitarian regimes such as Burma, North Korea, or Sudan. Those companies in turn

use the money to enter those markets. Some of these countries are plagued with corrupt

government authorities that frequently require them to give substantial bribes to allow

them to operate in those nations. By financing these companies, banks are allowing

money to flow into these totalitarian regimes which have no respect for human rights

and who use this money to strengthen their positions in their respective countries. The

fundamental problem is not that a company be present in a country with a repressive

regime, but that its business there is somehow complicit in propping up or perpetuating

the repressive regime.

5. Financing of companies with little or no commitment to social

responsibility:

The banking industry usually grants credit facilities to companies, and helps in

raising capital in the financial markets, to companies operating with no socially-

responsible agendas, or with little commitment to one. We are referring, amongst

others, to companies operating in third-world countries that allow child-labor,

overwhelming pollution of the environment, black economies, and so forth. We have

observed companies that have little respect for their workers and which have

consistently violated labor laws (mainly in developing countries) having no problem

securing credits from well-known banks. So far, banks have not been interested in

questioning clients about their human-rights or social-impact agendas. Banks tend to

look at the risk-return ratio of their investment as the sole basis for granting the credit.

Some banks are financing companies, for instance in the infrastructure industry, that

operate in a highly utilitarian way in some countries. Some infrastructure developers,

for example, that build water dams around the world have been accused of impacting

the communities in which they operate by forcing the displacement of people from their

home communities to build the dams wherever it is more economically convenient for

them to build them, regardless of the social impact this might have. Moreover, these

companies have been accused of manipulating potable water sources in poor countries

by linking itself to corrupt governments like the Burma Junta or the regime in Sudan.

Banks lending money to companies like these facilitate their operations, and thus, often

their wrong-doing. Making money available to companies operating in this manner

fuels their wrong-doing. Funds channeled to these types of companies can easily end up

in the hands of those totalitarian regimes. These funds are not only the bank’s money,

but more importantly, the individual investor’s money.

6. Ecological Impact:

We should expect banks to start looking more in detail at the potential ecological

damage that their clients could be generating when receiving financing from them.

Companies known to be involved in activities that result in substantial environmental

damage through the extraction of fossil fuels for instance; companies polluting the seas

through the release of toxic chemicals; companies that manufacture products which

persist in the environment and are linked to health concerns; and any other company

damaging the world should not receive financing so easily as they do today from banks

and financial institutions. While we recognize that avoidance of all possible

environmental damage is often very expensive and hard to achieve, we believe that the

efforts should be at least seriously pursued. We expect companies to actively search for

a balance between their activities, their production processes, their use of natural and

human resources and the respect for the environment.

The same goes for companies involved in unsustainable harvest of natural resources,

including fishing, timber, and other natural resources should also be severely

questioned by banks when asked for financing. Moreover, banks, pension funds and in

general, every investor, should be very cautious when it comes to buying or holding

securities (be it bonds, shares, etc.) in all these kinds of companies. By investing in these

environmentally unfriendly companies, financial institutions give them access to

important sums of capital, which in turn, results in larger environmental damage.

The same rationale goes for companies involved in aggressive, unnecessary animal

testing of cosmetics and household products or ingredients. We recognize testing is an

important step of many manufacturing processes; it is abusive, unnecessary, excessive,

testing which we want to avoid. Intensive farming methods, blood sports, trade in the

furs of endangered species, and other animal unfriendly businesses are also of our

concern when they make use of animals for unnecessarily violent and superficial

entertainment activities.

7. Financing, donations, and sponsorships contrary to the good of the

family:

As financial institutions handle huge amounts of capital, the impact of their

donations and sponsorships can be substantial and the money they channel through

donations can have important impact on society. In this respect, we are particularly

concerned with banks giving active support to organizations that advocate against the

institution of family and against family-values. As we are convinced that the family is

the basis for any healthy society, we are interested in seeing banks staying away from

initiatives that somehow can affect the integrity of family or attack family values in any

way. These activities could include granting financial support to causes that actively

promote activism against family values. While we acknowledge that there are other

points of view regarding the value of families and their role in society, we prefer to

keep our investments, and recommendations for our clients’ investments away from

companies promoting non-family friendly causes and activism. We prefer not to

generate our wealth from investing in companies that opt for financing, promoting, and

supporting entities and organizations that do not share our view on family and family

values as the cornerstones of society, peace and harmony.

8. Involvement in social enterprise:

The banking industry plays a key role in the development of the markets in which it

operates. By lending and raising money, a bank can effectively help develop a

community, but further than that, a bank is expected to get actively involved in

supporting the development of that community in which it operates. More and more

banks and financial institutions are praised when they support organizations such as

cooperatives or credit unions, or get involved in financing of community

initiatives. Given the fact that a bank benefits directly from the economic resources of a

community, we would be concerned when a bank openly neglects to help those

communities in which it conducts business.

Is a better banking industry possible?

The answer is absolutely YES. Better, ethically-responsible, respectful banking

and financing industries are not only possible, but also highly desirable, and they are

already starting to emerge. Some banks, mainly small institutions in developed

countries have realized the importance of being ethical beyond their internal Code of

Values, that is, beyond paper and beyond what is strictly within its operations.

Individual investors will play a key role in putting pressure on banks and regulators to

let them know that banking practices cannot go on as independent of ethics any longer.

The relevance of what banks do with the people’s resources is material.

A number of organizations around the world are starting to pay attention to how

money is being used and to the moral implications it has. Some important institutional

investors are becoming much more concerned with the handling of their investments.

Institutions like the Government Pension Fund of Norway, the so called,

“Folketryfondet”, the world’s largest single holder of equity securities, has been

implementing strict ethical criteria to handle their investments. Some bank-industry

watch-dogs like Bank Secrets Organization or Netwerk Vlaanderen of Belgium, have

started to lobby regulators to implement stronger policies for the banking industry.