Ten Recommendations for the Ethical Rearmament of Banking

The image of banks has deteriorated. They urgently need to improve their image and regain people’s trust. It will be good for them and society. It’s true that some banks were more responsible than others for the tarnished ethical reputation most people now have of financial institutions. And although banks are not the only parties responsible, a very significant list of ethically questionable practices has been attributed to banks or, more specifically, to some senior bank executives.

Here are some examples: deceit in the placement of preferred shares; holding and selling financial products with hidden “toxic” assets; mortgages with abusive clauses; questionable million-dollar remunerations, ironclad clauses and pensions for senior bankers; helping create a real estate bubble by granting loans based more on greed than prudence; performing operations involving excess risk; foreclosing mortgages with very little social awareness or interest in finding alternatives; showing a lack of initiative in providing loans to feasible companies; aiding and abetting clients place assets in tax havens; and professional incompetence as board members (as in the case of many savings banks). Some cases even involve manipulating massive amounts of data, as in the case of the LIBOR scandal.

Why Laws Were Unable to Prevent This Behavior?

Many people wonder why the laws in different countries were unable to prevent this unethical behavior. It seems to me that there are at least two reasons. The first goes like this: every law has its loophole. When there is no ethical safety net, there are many ways of getting around the law . The second is that life is more complex than rules. Scandals happen first and laws are passed later. We therefore need something else besides a set of rules to control the behavior of people and institutions: we need to understand and pursue ethical values.

There is a clear need for an ethical rearmament in the banking industry. But how can this be done? It would be simplistic to try to solve complex situations without delving into the specific details of the topic. But there are some basic recommendations that are easy to understand and that can help contribute to that much-needed ethical rearmament. Some of them are now covered by laws, while others aren’t. Regardless, ethics are not in the law itself, but in the justice that justifies them. These are the recommendations we propose:

1. Creating a responsible corporate culture where the key should not be the mentality of maximizing profits at all cost, but the banking industry’s ethical-social function with reasonable economic profits and social benefits. Banks comply with their social function by prudently moving the assets deposited by savers  and facilitating the loans that families and businesses need to be able to grow, generate employment and, therefore, generate wealth. When banks and financial institutions started with excessive risk and questionable practices, they stopped performing this function, which is necessary for society’s economic development. This social function is what justified bailing out the banking industry. It may not have been a popular decision, but if the financial system had not been bailed out and had failed, it would have had devastating effects  not only on specific banks, but also on economic activity in general, resulting in the paralysis of society as a whole.
2. Acting with transparency and explaining relevant information, even more than is required by law. The effect of holding toxic assets and placing preferred shares with deficient information was devastating  and it is important to show that the lesson has been learned. Neither mortgage securitization nor holding toxic preferred shares is intrinsically wrong, but each must be explained clearly and these shares should not be offered to anyone who cannot easily understand them.
3. Administering funds with prudence and transparency. Some banks went bankrupt due to imprudence or negligence in the administration of funds, often accompanied by a complete lack of transparency. For example, the banking industry saw real estate as a gold mine where large amounts were handled, because banking becomes profitable when large amounts are involved. But the money available to the bank is not the sole property of the board of directors. They often only own a small percentage. Thousands of small shareholders and savers were negatively affected.
4. Granting loans with a sense of ethical-social responsibility by considering the activity the money will be used for and its social value. Bank managers are not responsible for just profitability and solvency. There is also an ethical and social responsibility that involves considering the contribution the loan makes to creating employment and generating wealth ethically. The responsibility of granting loans also makes it necessary to deny them when they are earmarked for activities and sectors where there is a lack of ethics (e.g., industries that do not comply with basic human rights or do not prevent pollution, or that work in pornography).
5. Not using their situation of power to abuse the needy. Having power can mean having more information or greater negotiating power. Imposing abusive clauses in mortgages and taking advantage of savers’ ignorance are two examples of the abuse of power in banking.
6. Failing to provide incentives and applying extreme pressure when making investment decisions. Clients often receive advice from bank employees because clients think bank employees can be trusted. A corporate policy pushed by senior banking managers who put pressure on their employees without any precautions can lead them to sell financial products without offering clients full, clear information, or without recommending that they buy other products that are more suitable to their investor profile. It is true that many of these employees are not investment consultants, but they may be considered as such by clients with savings who have little knowledge of finance, especially if these employees actually make recommendations. It is necessary to avoid situations in which the trust placed in these employees is abused.
7. Acting with moral imagination and social sensitivity. Moral imagination causes us to find creative solutions that are ethically better than the solutions most commonly made. One of the harshest criticisms of banks involved asking them why they were so socially insensitive when it came to mortgage repayments and the resulting foreclosures. Is dation in payment really not possible in many cases? The lack of determination when trying to solve a problem that directly affects the basic needs of thousands of families indicates a lack of social sensitivity. The banks’ protocols may not have included indications on how to act and some people may have even felt it was not the banks’ problem. But the problem was real and, in many cases, the financial institutions were too slow and inflexible to take action and also lacked imagination.
8. Not cooperating with the questionable behavior of others. This includes everything from collaborating with money laundering to providing technical assistance to aid in fraudulent tax evasion in tax havens. Tax havens are known to have no taxes or very low taxes. They are also known for keeping their clients’ secrets. Banks should not be accomplices to their clients’ questionable activity, even if those clients are very important people.
9. Acting with a sense of corporate citizenship. This means that banks should act and be seen as social agents that are concerned about social problems , even when these problems are not directly included in the bank’s mission statement. Many banks set aside part of their profits for social causes that would otherwise go uncovered. This should naturally not be used to cover up questionable practices, but should be praised. These actions are not just a way for banks to give back to society part of what society helped them earn, not including taxes. They are also a way for the bank to be community-minded, which society generally views highly.
10. Ensuring compliance by focusing on integrity. Having well-established and suitably applied codes of conduct and other means of self-regulation can help, but the focus should be on a shared mentality of integrity that goes beyond mere compliance. This will prevent the common attitude of saying one thing (“We comply”) and doing another based on a lack of ethical integrity.

At IESE, we aim to help companies and banks work well (with a professional and ethical base), provide a good service in noble competition and, as a result, be profitable and contribute to progress and the humanization of society. But you may wonder if that is even possible. How can being competitive be compatible with being ethical? It’s a challenge that calls for imagination and hard work, but honesty and integrity, along with the resulting trust, are also important competitive elements.

Some IESE lecturers give thought to this matter and even organize international conferences like the one to be held shortly in Barcelona from June 30 to July 1, 2014. Experts from all over the world will come to discuss this topic and try to continue making progress.

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Dr. Domènec Melé is a professor of Business Ethics and holds the Chair of Business at IESE.
He has  a Ph.D. in Industrial Engineering, from the Universitat Politècnica de Catalunya; a Ph. D. in Theology from the University of Navarra, Spain; and a Master’s degree in Science, from the Universitat de Barcelona.