From Crisis To Conscience: Reimagining Ethical Banking

The financial crisis of 2007 has demonstrated that trust in financial institutions is eroding rapidly, and ethical business practices are being abandoned quickly. The LIBOR fallout in 2011 is staring us in the face. Established institutions are causing tremors in economies. A time has come to examine the roots of the change and usher in a new era based on certain values that have a degree of permanence and these should eventually lead to regaining lost trust.

Business ethics, people say, is an oxymoron as it is difficult to marry ethics and business. It isn't easy to agree with such a premise. It is the attitude to life and the value system that one has to cherish and live with. Values are not like a sensex graph varying every day or with every person. Values are universal. It is the application of values that has been changing.

At one of the branches of a public sector bank, customers' accounts were debited to the tune of Rs. 1.5 crores in the third week of January 2024 by an employee, aided by negligent supervision or systemic lapse. Six months back, in another public sector bank, employee fraud robbed customers' accounts again to the extent of Rs.2 crores. Almost at the beginning of the year 2024, there were employee frauds again, running up to Rs. 1 crore in the leading private sector bank. There were again some frauds relating to the housing loan sanctions and disbursals. Investigations into the Citibank fraud of nearly Rs.400 crores a year or so back may have been completed but not much is known.. There are ATM loots and frauds. Economic offenses related to banking have been on the rise. All these constitute the operational risk for which capital allocation on average has been of the order of 4-5 percent.

The great recession led by the subprime crisis has already eroded trust in the financial system, and in order to restore trust, governments indulged in huge bailout packages that cost the taxpayer heavily. The fraudsters seemed to have the guarantee of the exchequer. And yet there's rarely a public conversation about what is ethically right and wrong in the banking industry, and how that contributed to the financial meltdown that is still ravaging national economies. Although bankers acknowledge that `mistakes' were made or there were `cognitive failures', they are often loath to dwell on their industry's ethical breaches. If there is no conversation on what is right and what is wrong and how soon the wrong needs to be acted upon and punished, faith in the financial system cannot be restored. While offenses come in the media glare, the extent to which they are tackled and with what correction to the system rarely finds a place in either the print or the visual media.

We've all benefited from the success of the banks in India. The growth of banking in India like those in many successful economies is in multiples of the growth of GDP. But that does not mean that all the growth is without pain and has been fashioned with clean hands. Many conferences and seminars are held at the national level at the behest of the Indian Banks Association and organizations like CII, FICCI, and ASSOCHAM. Rarely have we spoken about how to decide what is proper and improper in terms of banking practices today.

Although the industry faces sweeping new rules and regulations, legality is not the same thing as morality. In some corridors of banking, people turned a blind eye to troubling practices as long as they were technically legal, or rationalized away their qualms by telling themselves that it was just the way business was done. There was a fragmented code of ethics in some corners, current and former bankers say where behaviours that people wouldn't tolerate in their personal lives were considered acceptable as long as they were confined to business.

The Observer broached the topic of banking and ethics with more than 50 people, almost all of them, bankers or former bankers. Only 10 of the bankers agreed to be interviewed on the record. Some said they would speak only under anonymity because they feared retaliation from their employers. Others said they did not want to talk because they disagreed with the idea that there had been ethical lapses in banking.

Before the financial crisis came to full force in 2008, shifts in the industry and society set the stage for temptation.

The 1999 repeal of the Glass-Steagall Act broke down the walls between retail and investment banking, allowing banks that take consumers' deposits to also engage in risky Wall Street-style gambles. At the same time, the government was aggressively promoting home ownership. And in 2004, regulators bowed to industry pressure to loosen rules about the reserves that investment banks had to hold, allowing them to take on more risk. In response, bankers issued mortgages to people who couldn't prove their income, making more money as they made more loans. The banks repackaged home loans into investment products and sold them off to pension funds and other investors, giving them less incentive to worry about whether the loans were good or bad.

The banking industry became a big profit centre in itself, not just a tool for moving money through the economy. The rewards got too big, too fast, and too seductive, many industry insiders agree. The banks' compensation structures made it difficult for employees to speak up if they saw anything that made them uneasy, current and former bankers said. Banks are bureaucratic institutions with a command regime akin to the army. The bosses rarely entertain open dialogue on any issue. 'Do as I say' is often the dictum. Unless one has a group who agrees on what he or she thinks, he dares not express an opinion on a policy, lest it is dubbed contrarian.

Governance Issues

The boards are fed with the information that the top management considers it expedient to feed them to get their nod. Most boards do not necessarily design an MIS that demands information on what they should see necessarily. If some independent directors raise the issues in an unexpected direction, the reply is will cross the bridge when it comes to the ridge'. When some things go wrong in the dealing rooms, the response is: `... We were just relying on people who we thought were the smartest people in the room'. Pope Benedict XVI, in his June 2009 "Charity in Truth" encyclical, noted the misuse of financial methods that had `wreaked such havoc on the real economy'.

He added: `Financiers must rediscover the genuinely ethical foundation of their activity, so as not to abuse the sophisticated instruments which can serve to betray the interests of savers'.

Reference"

New capital regulations can't solve all of banking problems, because there will always be ways -- legal, if nuanced ways -- to get around them.

The glue that holds markets together is a sense of trust and self-regulation among the participants, Baxter said in a recent speech in Johannesburg, South Africa. `Mutual understanding endures only based on a deep and widespread commitment to moral integrity within a market', he said. `So even though it has lately been unfashionable to focus on market morality and ethics, we ignore the moral dimensions at our peril', he added.

There have to be consequences for wrongdoing or even just for poor performance - consequences that preclude `golden parachute' severance packages and, many say, government bailouts.

There is also a push for banking to become a smaller, simpler, less profitable industry. The original purpose of banking was to take in deposits and make loans so that the rest of the economy could function, but it became an industry focused on making profits for itself through esoteric products with questionable usefulness. John Mack, the retired CEO of Morgan Stanley, said at a speech in Charlotte this year that the banking industry needs to return to its roots.

(This represents part of Chapter-III of MSME Business Environment and Challenges of “The Story Of Indian MSMEs by the author; author is an economist and risk management specialist, and former Dean of Studies, ASCI, Hyderabad)