Ethics in banking and finance

Johan Graafland Tilburg University / European Banking Centre The Netherlands

Some worrying facts

14% of Dutch population trusts banks

Two Dutch banks nationalized

Public debt and austerity

Between 1987 and 2011 salaries in banking sector increased by 300% against 200% for other sectors

Since 2008 salaries increased by 7% in banking sector against 6.5% in other sectors (last year 3.1 against 1.8%)

Gap between society and bankers

Public accuses bankers of injustice, greed etc. Bankers:

This is bank bashing Public does not understand banking Applies only to a few bankers (rotten apples) Pressure of the market: bankers cannot be blamed Crisis result of system failure Not only bankers are greedy It is a matter of envy

Questions In what sense did bankers morally fail? Why not only blame bankers? How can we close the gap?

Professional ethics in finance: an application of MacIntyre’s virtue ethics

Practice = any complex form of socially established cooperative human activity through which goods internal to that form of activity are realized in the course of trying to achieve those standards of excellence, which are appropriate to that activity.

A virtue is an acquired human quality, the possession and exercise of which tends to enable us to achieve those goods that are internal to practices.

The internal good of banking

Derived from the mission statements of several American Investment banks, Deutsche Bank, several Dutch banks like ING and the Rabobank Group, Santander, Societe Generale.

to offer customers financial products that optimally meet

their needs at competitive prices

Three professional virtues Integrity

“Integrity and honesty are at the heart of our business. We expect our people to maintain high ethical standards in everything they do, both in their work for the firm and in their personal lives” (Goldman Sachs)

Due care “providing those financial services considered best and most

appropriate by our clients, ensuring the continuity of those services, with a view to the long-term interests of the client and by demonstrating our commitment to our clients and their environment, in ways that help them achieve both their personal, social, and economic ambitions.” (RABO bank)

Quality and accuracy “As a German global brand, a desire for accuracy, thoroughness and

quality runs through our organization. We understand issues in depth. This is why we keep things simple and clear.” (Deutsche Bank)

Credit crisis as a test of the moral quality of banking

Internal good: providing in the needs of customers

integrity

Due care

quality

On the whole no deception;

Only in some cases

General lack of due care for interests of clients

Misunderstand the nature of risks

How financial institutes deal with customers: A personal experience

1997 started stockplan with Aegon. Montly investment Є 136.

1999: I read in newspaper that I payed a substantial premium for life insurance

Content insurance: If I would die during between 2005 and 2010, my wife would receive my deposit with an annual interest rate of about 1% per year

2007: I received information that 25% of premium was spent on insurance premium

2012: the total net nominal return was 0% 2012: I received compensation of 0.17%

Other virtues

Courage: to withstand pressure to take more risks and to unethical behavior;

Prudence Humility: to learn from criticism Temperance: to aim at realistic returns Justice: to take a fair share in the burden

Psychological explanations for Unethical Behavior

• Obedience to authority • Conformity bias • Incrementalism • Groupthink • Overoptimism • Self‐serving Bias

Financial crisis: beyond individual responsibility of bankers

The moral shortcomings of bankers and other professionals in finance should not be overstressed

Anglo Saxon model of capitalism Deregulation of banking sector in seventies and eighties

Fierce competition stimulated the rise of mega banks; moral hazard (too big to fail)

Risks became more homogeneous system risks increase; trust in system instead of trust in individual banks

Short term focus on maximizing shareholder value

Five types of level/instruments to foster good functioning of financial sector

Market forces Crisis shows market failures: lack of transparency, external

effects, bounded rationality

Government regulation Intervention and supervisions failed

Institutional design at industry level Sector codes of conduct and compliance schemes

Institutional design at company level Governance structures; informal culture

Virtues of individuals Embody virtues

Conclusions

A renewed sense of the social responsibility of banks and the accompanying professional virtues will probably not suffice to restore the trust of clients, if the incentive structure as it was prevalent in the Anglo Saxon model of capitalism is not changed: Changes in the corporate governance of banks Be careful with competition

At the same time the banking profession should undergo a process of professionalization strengthening the sense of public responsibility, because without a refocusing on the internal good of the practice of banking, new regulation will just be avoided in new ways.