Deep change to banking ethos needed

How best to respond to the iniquities uncovered within the financial sector in recent years? Better communication, harsher punishments and stronger regulation have been touted as ways to hold banks to account – but it is important to look more deeply to achieve real and lasting change. Professor André Spicer assesses the options.

In December, authorities in the United States announced that they would fine Standard Chartered Bank $327m for disguising transactions that violated US sanctions against "rogue regimes" such as Iran, Libya, Sudan and Libya. Later the same day, HSBC announced that it would pay US authorities $1.9bn to settle claims that it had engaged in money laundering for "drug king-pins and rogue nations".

These revelations followed news about overly risky lending practices prior to 2008, mis-selling of payment protection insurance and the manipulation of the Libor rate. The upshot of all this bad news is an increasingly widespread agreement that something desperately needs to change within many of the large financial institutions. What is less clear is exactly how the banks might be held to account.

For some, addressing problems with the financial community is only a matter of better communication. According to some, we have witnessed too much so-called banker bashing. This means the good done by City of London for the United Kingdom as a whole has been ignored. Some are concerned that this bad press will result in global financial institutions becoming increasingly hesitant to do business in London. If the problem is poor public perception, the solution is an information campaign that reminds the wider public of all the good done by the City.

There is no doubt that the financial sector makes a huge contribution to the UK economy in various ways. But despite what some may think, the public is not stupid. They know the banks are one of the few globally competitive sectors in the UK economy. They also know that this sector has been riddled with irresponsible behaviour. While changing the public debates about the banking sector might make for a more balanced debate, it certainly will not address the root causes of the problem.

Another increasingly prevalent approach to addressing problems within the banking sector has been the use of increasingly severe punishments. Until recently, authorities have been somewhat hesitant about punishing banks with large fines. Often, charges for financial misadventures were little more than a slap on the wrist. Recently, though, national authorities seem to be far more willing to dole out more significant fines. And the costs of recent rulings often go far beyond the immediate fine which banks pay to state authorities. Typically banks that pay large fines are also punished by the markets with drops in share prices. The assumption seems to be that by making bad behaviour increasingly costly, banks are likely to cease and desist.

Certainly punishment can make some difference. In respond to the recent settlements with US authorities, both HSBC and Standard Chartered have put in place more rigorous client vetting systems. However, punishing the banks can come with some important problems. Perhaps the most notable is that it jacks up their cost of doing business higher. These increased costs are likely to be passed on to their clients - which is ultimately the broader public.

A third option for addressing irresponsible behaviour by banks is creating better rules of the game. Many point out that the lax regulation of the financial sector during the past two decades has given ample space for malfeasance by bankers. To address these concerns, financial regulators have started to tighten up the rules. At the international level, we currently see the details of Basel III being thrashed out. This would see banks being required to hold significantly higher ratios of capital to lending than previously.

Various nation states are also developing new regulatory regimes designed to reign in the banks. In the UK, the Financial Services Authority is developing a package of regulation that will seek to separate the risky practices of investment banks from the more mundane activities of retail banking. While these regulatory reforms are certainly an important part of the picture, they can also come with some significant shortcomings. Perhaps the most notable of these is that many of the banks are very well versed in finding their ways around new regulation. This means new rules might be a boon for lawyers, but on their own they can have a fairly limited impact.

If communication, disincentives and regulation on their own are not enough, what options are we left with? To achieve real and lasting change within the banking sector, it is important to look at a deeper change in the ethos of the industry. This involves thinking about what the central values and virtues that are systematically reinforced and encouraged within banks. Values of extreme risk-taking have been systematically encouraged and reinforced throughout the industry. The result has been bankers going out of their way to engage in highly risky and even dubious business dealings.

What might make a real palpable difference is a shift in the shared culture and values within the industry? Perhaps a re-emphasis on the traditional virtues associated with banking such as prudence, accountability and accuracy would an important step in this direction. Achieving this kind of cultural shift would require individual banks and the industry as a whole to seriously reflect on the kind of values it celebrates and rewards. This kind of reflection might be a slow and painful process, but it could also help to make the UK financial sector more sustainable into the 21st century.