Banking Standards

Submission from the Church of England’s Mission and Public Affairs Council (S035)

Summary.

· A flourishing economy requires sound banks. Simply waiting until memories of recent scandals fade would not be an adequate strategy for rebuilding public trust. Regulatory and cultural changes are necessary.

· Money is, as a Doctrine Commission report of 2003 said, ‘a human good and an essential instrument for any human society which aims at human flourishing.’ At the same time, the Biblical claim that ‘the love of money is the root of all evil’ holds true because, ultimately, treating money as an end rather than a means is dehumanising for creatures made in the image of God: ‘You cannot serve God and mammon (wealth)’.

· The roots of the crisis in banking are, therefore, ethical. We discuss this below in terms of a culture of the virtues which could answer the question, "What would it mean to be a good banker?" A strong and virtuous professional culture in banking is the best way to guard against abuse without constraining innovation.

· Inadequate levels of competition have distorted the proper operation of markets and increased the problems of ‘too big to fail’. The banking sector has violated some of the fundamental principles of the free market economy: free entry and exit, the avoidance of monopoly and oligopoly, and independence from external subsidy. We hope the Commission will look at ways to introduce greater competition – and perhaps greater local connectivity.

· The nature of risk – and the basis of remunerating people for managing risk – has been badly misunderstood within the banking sector. Those who have been handsomely rewarded for risk taking have not been those who have borne the consequences of those risks.

· Improving the public’s experience of retail banking – even though it should be, rightly, more distinct from investment banking – may do much to restore public confidence in the banking sector more generally.

· Globalisation has made it harder but not impossible for national governments to shape and regulate the context in which banking takes place. The crisis is an opportunity for concerted international regulatory action to make the interconnected international financial sector more resilient.

The Church of England and Public Ethics

1. The Mission and Public Affairs Council is the body responsible for overseeing research and comment on social and political issues on behalf of the Church of England. The Council comprises a representative group of bishops, clergy and lay people with interest and expertise in the relevant areas, and reports to the General Synod through the Archbishops’ Council.

2. Part of the responsibility of the MPA Council is to offer insights from its experience and its ethical tradition on matters of public concern. The crisis in British banking (and the wider global banking context) affects every citizen – and will affect generations to come – and so is a legitimate area of concern for the churches and for Christian ethics.

3.
The Church does not presume that it possesses unique specialist knowledge which can solve the problems which the Parliamentary Commission is investigating. The approach which the church has taken over many decades is to apply Christian ethical reasoning to practical problems in a way which avoids the Scylla of bland generalities and the Charybdis of unwarranted specificity. This approach, sometimes known as "middle axioms" was developed by the Church of England in response to the crises of the 1930s following a previous financial crash and the subsequent deep recession. We believe that the approach can offer useful insights to the similar problems of today.

4. As is well known, the great Abrahamic faiths (Christianity, Islam and Judaism) are traditionally uneasy about the morality of usury. It is, however, too simple to argue that the church cannot, therefore, support an economic model in which interest and indebtedness are central features. This is not the place to explore the extensive literature about Christian ethics and usury – suffice to say that, along with Judaism and Islam, Christianity has always recognised that money, interest and debt are not merely technical problems for economists but are moral questions for everybody. In a modern market economy, interest and debt may be unavoidable, but they are not amoral matters. [1]

5. Importantly, Christian ethics is not simply a matter of applying theological insights to contemporary dilemmas as if everybody shares the same religious starting point. Our responsibility is to join with others in exploring the nature of the Common Good in a complex society.

6. The widely-accepted notion of the Common Good is, in itself, a challenge to the kind of atomised individualism which characterises a great deal of public discourse. Applying the notion of the Common Good to questions of banking is significant on two counts: it affirms the principle that morality is evaluated by broad social outcomes as well as individual conduct, and it makes it easier to consider banking as an activity in which the majority of the population has a direct stake and in which every citizen of the world has at least an indirect interest.

7. In the response to your specific questions which follow, we have not attempted to answer every point as there are some areas where we have no special insight to draw upon. We have restricted our responses to those where we believe that the Christian ethical tradition, and our experience as a church which is present in every community of England, have something useful to say.

Responses to the Commission’s Questions.

Q 1. To what extent are professional standards in UK banking absent or defective? How does this compare to (a) other leading markets (b) other professions and (c) the historic experience of the UK and its place in global markets?

8. We have no doubt that there are many people involved in banking who aspire to high standards of professional conduct – such standards and such people are rarely entirely absent from any profession. But the critical factor is not the personal standards of individuals but the corporate context which can promote and sustain, or undermine, such standards.

9. There is evidence that in many professions, but notably in finance and banking, practitioners who have a strong moral sense which they seek to live by in their private lives believe, rightly or wrongly, that such standards and ethics are impossible to apply in the corporate world. They are certainly clear that the culture of their working environment does little or nothing to encourage virtues such as truth-telling, loyalty and prioritizing what is right over what may be expedient. [2]

10. There is also evidence that the culture of banking has changed in the last 25 years or so. In 1991, a study of professionals in different sectors suggested that many in retail banking, who had entered the profession believing it to be about serving the customers’ financial interests, were dismayed that the job had come to value the sale of financial products as the objective, with little thought for customers’ needs. [3] The shift from a culture of personal service to one of maximizing sales appears to be more marked in banking than other sectors.

11. Public disquiet about the scale of bonuses, especially in investment banking, has shed some light on a culture where large bonuses are valued, less for their monetary worth than for their significance as status indicators within the industry. This in itself suggests that the culture of banking has lost touch with matters of virtue – in short, there seems to be no reflection upon the question, "What would it mean to be a ‘good’ banker?" beyond the crude measure of monetary profit. To speak of professional standards in a culture with no internal discussion of what it might mean to be virtuous in that culture, is to be part of a very attenuated and morally inadequate discourse.

12. This is not a problem confined to the banking sector. Across a range of professions the trend in recent years has been for money and material rewards to have an increasing impact on culture and standards. But in the financial sector the trend seems to have been more acute than in those where there is perhaps a stronger sense of working as part of a collective endeavour for a wider good where value cannot be measured solely in terms of the bottom line.

13. Professional standards are closely linked to the idea of character. Professionals are regarded, not merely as "hands" to do a task set by others, but as people whose character is shaped by an understanding of the virtues and the "internal goods" associated with their profession. Self regulation is often regarded as intrinsic to professionalism, although no profession works completely outside laws, rules and structures imposed by society at large and sometimes enshrined in law, for the sake of the Common Good.

14. One important dilemma with which every profession has to contend is whether reliance on character, formed as part of professional education, training and culture, is enough to ensure high standards. The medical profession, for example, was deeply discomfited by the exposure of the activities of Dr Harold Shipman and one consequence was an increased bureaucratisation of GP’s work which necessarily supplemented the traditional reliance on trust with the more tangible safeguards of process and audit trails.

15. There are dangers in trying to draw too many parallels between the Shipman case and what has happened in the financial sector over the past few years. The Shipman case was essentially about the inadequacies of the system to pick up and prevent extreme, almost unimaginable behaviour by one individual. It did not call into question the ethics or competence of the medical profession more generally.

16. The financial crises and emerging scandals of recent years have, in contrast, raised profound concern not simply about the ability of the system to prevent extreme and criminal behaviour by individuals but about the system itself and a whole cadre of professionals within it. The question is not whether systems have been adequate to identify and deal with the bad apples but whether the whole orchard needs replanting.

17. Smarter regulation is, therefore, part of the answer, but only part. The sharp question is how banking can restore its internal professional standards in ways which communicate trust both within the industry and with stakeholders throughout the community.

18. An exploration of the ways in which banking serves the common good, the virtues required of bankers and the structures and culture which might nurture and sustain those virtues, is needed to prevent the current crisis simply leading to further impersonal and rigid regulation in which professional judgment is either stifled or emerges in rule-bending.

19. To sum up:

· the crisis of professional standards in banking is one of corporate culture into which individuals have been drawn, rather than one caused by wicked or wrong-headed individuals subverting an otherwise benign culture;

· further regulation and the regeneration of a culture of virtue are both needed.

· some, smart, new regulation of the banking industry is needed to assist in rebuilding a more virtuous corporate culture by making overt the agreed boundaries within which good bankers must operate.

· practices of virtue in professional contexts need to be reinforced by examples and role models and often by a new set of principles and boundaries.

Q2. What have been the consequences of the above for (a) consumers, both retail and wholesale, and (b) the economy as a whole?

20. Consumers are participants in the economy as a whole so, considering consumers of banking services in the widest sense, it is impossible to separate (a) and (b).

21. The impact of recession on the most vulnerable is both well documented and deeply injurious to a cohesive society. And, in so far as all gain from greater social cohesion, all lose when social bonds are damaged through widening material inequality and the exclusion of significant numbers of people from meaningful employment.

22. It has frequently been observed that the banks had been driven to create ever more inventive financial instruments which helped to contribute to continual economic growth and therefore tacitly served the political priorities of successive administrations as well as boosting their own profits. Economic growth is a good thing but only to the extent that it is sustainable, realistic and achieved morally.

23. A flourishing economy in a functional society needs banks in which people can trust – the small saver as well as the major commercial client. The damage done to the reputation of banks by the current crisis could prevent the banks playing their most effective role in promoting recovery. Restoring trust frequently requires symbolic, as well as merely effective, change to take place.

24. One insight from the Christian tradition of penitence and forgiveness is that it is often not enough to put matters back to where they were before things went wrong; some demonstration of a change of heart by means of restitution and a visibly robust refusal to let the same failings occur again, is necessary before a bad situation can be made good. Exactly what kind of action by the banks, or by the government, would be necessary to restore trust in this way would probably emerge if the debate about banking ethics were to take place openly in the public realm.

25. We believe that the restoration of public trust in the banking industry would be in the interests of all. To achieve this is not just a matter of technical "fixes" but may require public, corporate, contrition for past failings, demonstrably robust structures to ensure that old mistakes are not repeated, and possibly some symbolic steps to assure the public that the corporate culture has changed.


Q3. What have been the consequences of any problems identified in question 1 for public trust in, and expectations of, the banking sector?

26. Many of the failures in the banking sector lay in the investment banking arm. But the public experience of banks, which does much to shape perceptions of the sector, stems mainly from their engagement with the retail arm. This, in itself, suggests that the carry-over of risk from one arm to the other has done damage to public confidence in retail banking. The future degree of separation between the two arms, or ring fencing between them as proposed in the Vickers report, should help with this.

27. Clearly the widely reported bonus culture, and the headline salaries, bonuses and remuneration packages of very senior bankers – packages that have not been visibly affected by the financial crisis which has brought austerity to the doorstep of most families – has gravely harmed the public perception of banking.

28. This is not simply an outworking of an undesirable politics of envy. It reflects a deeply felt and sound belief that what has happened is unjust. The fact that those who presided over actions by their banks that were disastrous for the common good walked away with large pay-offs has simply fuelled the damaging notion that the whole culture of banking conspires to facilitate personal greed, with huge rewards for success and only slightly smaller rewards for failure.

29. The residual belief (exploited by numerous advertisements for banks) that banks are friendly, family-oriented, institutions which have the customers’ needs as their raison d’etre, has taken a possibly terminal blow. Our social culture is not so rich in benign and trustworthy institutions that this loss can be greeted with equanimity.

Q4. What caused any problems in banking standards identified in question 1? The Commission requests that respondents consider (a) the following general themes:

· the culture of banking, including the incentivisation of risk-taking;

· the impact of globalisation on standards and culture;

· global regulatory arbitrage;

· the impact of financial innovation on standards and culture;

· the impact of technological developments on standards and culture;

· corporate structure, including the relationship between retail and investment banking;

· the level and effectiveness of competition in both retail and wholesale markets, domestically and internationally, and its effects;

· taxation, including the differences in treatment of debt and equity; and
other themes not included above;

and (b) weaknesses in the following somewhat more specific areas:

· the role of shareholders, and particularly institutional shareholders;

· creditor discipline and incentives;

· corporate governance, including
  - the role of non-executive directors
  - the compliance function
  - internal audit and controls
  - remuneration incentives at all levels;

· recruitment and retention;

· arrangements for whistle-blowing;

· external audit and accounting standards;

· the regulatory and supervisory approach, culture and accountability;

· the corporate legal framework and general criminal law; and

· other areas not included above.

30. (i) Risk. The question of the incentivizing of risk is a good example of how a failure to consider ethics in terms of the Common Good can distort judgments. The rhetoric of the risks taken within the banking sector tends to exclude the demonstrable fact that the consequences of banking failures have been borne by the people of the nation, and indeed of the world, and not just by the so-called risk takers.

31. This would appear to be an example of the kind of blindness to the Common Good which can develop within a culture with strong internal behavioural norms, a very strong focus on the shared end rather than the ethical means, and a substantial disconnection from the concerns of a wider community and society. Jobs in investment banking in particular have been characterised by extraordinarily long hours and intensive focus on the job to the neglect of wider social hinterlands. Whilst such intensive single-mindedness has long been recognised as bad for the well being of the individuals concerned (even though they may regard their remuneration package as sufficient compensation) the disconnect from other people’s lives has contributed to an excessively narrow interpretation of the nature of risk.

32. The point is not that bankers should avoid risk but that the banking industry should work to a much wider calculus of the extent and nature of the risks which banking practices impose on people way beyond the industry. A culture which is alert to the notion of the Common Good would not have misunderstood the social nature of financial risk in such an egregious way.

33. (ii) Globalisation. To a great extent, the City of London has developed a competitive edge by shrewdly going with the grain of globalization – in itself on balance a good thing and in any event a fact of life – and seeking to ensure that its regulation of the financial sector is, at worst, no more burdensome than that of other potential competitors. The balance struck has been a conscious and in many ways justified national choice. The view sometimes expressed that globalization has imposed identical constraints on all economies and taken away all national sovereignty in economic matters is a myth.

34. What the crisis has revealed, however, is the extraordinary interconnectedness of the international financial sector and the need not only to review the UK’s regulatory framework but to seek to generate some common international approaches to rebuild global resilience. Just as it would be misguided for the UK to throw away its competitive advantage by unilaterally introducing onerous regulations or tax regimes it would be dangerous to engage in a competitive, deregulatory chase to the bottom.

35. (iii) Innovation and technology. The problem seems to have been that innovative models and products were developed without the framework of a strong ethical corporate culture. This, plus the increasingly impersonal nature of trading as a result of developments in IT, has tended to detach trading from being a transaction between persons and to obscure any sense that whole communities might be directly affected by a particular transaction.

36. "My word is my bond" only works if it is possible to identify with whom the bond is supposed to be forged. The impersonal nature of trading is one factor in the miscalculation of risk and one factor in the diminution of the reputation of the industry. If old ways cannot be returned to then new ways of demonstrating the personal and "real-life" implications of a transaction need to be sought.

37. (iv) Corporate structure. Many, including Vickers, have suggested that the retail and investment arms of the banking sector should be separated. The point made earlier, that the reputational damage to the retail sector may be hard to restore if some separation is not achieved, gives force to this argument. Moreover, the activities and, perhaps most of all, the professional qualities required to flourish in the two sectors, are significantly different. We would, however, commend to the Commission for further thought and evidence gathering the question of what the implications of separation will be for the cultures of the two sectors and what will be needed to ensure that both are conducive to the common good. To put the matter more bluntly, the effect of separation must not be to create an ethically mature and consumer friendly retail sector sitting alongside an even less well regulated and socially irreseponsible investment banking sector than in the past.

38. (v) Competition. In seeking to understand the nature of the current financial crisis, MPA staff have held informal discussions with a number of practitioners in different City of London institutions. We have been very struck by the widespread view among practitioners in, for example, the foreign exchange and insurance sectors, that the banks have enjoyed an unwarranted oligopoly which was neither in the nation’s nor, ultimately, the City’s, interest.

39. We do not have the specialist knowledge to know the exact impact of the relative lack of competition between British banks. We do note, however, that monopoly (or near monopoly) has always been regarded by market theorists as inimical to the proper functioning of markets, and yet that the market system of itself (as Adam Smith among others noted) contains an inbuilt tendency towards monopoly.

40. We do not regard it as an accident that a sector of the economy which most robustly championed the free, unregulated, market economy should have found itself a victim of that innate tendency toward monopoly. Adam Smith recognised that markets need to operate within an external moral structure if they are to flourish, but that markets of themselves do not sustain such moral structures. This points back to our earlier observation that whilst some external regulation may be needed to restore probity to the banking sector, an internal discourse of ethics and virtues within the sector is also a worthwhile objective for reform.

41. This sense that banks have been championing a free market ideology whilst claiming exemption from its rigours has been exacerbated by the suggestion that the banks have become "too big to be allowed to fail". The principle of free entry and exit is fundamental to a market economy and yet the exit of a bank from the market place is seen as unthinkable. The ready acceptance by the banks of vast public subsidy also appears to violate the free market principle that the banks have commended to everybody else. Competition is fundamental to the operation of a viable market economy and the way the banks in Britain have evolved into an oligopoly seriously violates that principle.

42. This affront to the principles of the open market is not merely a theoretical or ideological problem but a moral one. The Governor of the Bank of England was right to warn that the notion that the banks were too big to fail and therefore had to be bailed out by public funds created "moral hazard" since such an implicit guarantee disconnected the behaviour of the banks from its moral consequences.

43. The virtual demise of the mutuals as they were swallowed up in the retail banks has also diminished competition in the sector. Having competition, not simply between companies of similar size, shape and ideology but between different sorts of financial institutions which can approach banking operations with different priorities, is clearly advantageous if achievable. Certainly the loss of most of the mutuals has meant a diminution of real competition in the sector as well as the loss of a distinctive banking ethos which might, conceivably, have proved more robust in preserving the moral dimension of finance and banking. It may not be possible to create the conditions in which new mutuals might emerge and flourish, but the key question demanding attention is that of diversity of banking models and priorities as a mark of a sector demonstrating genuine competition.

44. We do not feel qualified to respond in detail to the other areas suggested for comment within Q4. However, some of the points already made could be applied to a moral evaluation of these other areas of concern.

Q5. What can and should be done to address any weaknesses identified? To what extent are such weaknesses subject to remedial corporate, regulatory or legislative action, domestically or internationally?

34. The UK banking sector was, for a period, extraordinarily successful on its own terms. It should be an aim of public policy to enable the sector to rebuild its reputation, its resilience and its international competitiveness. There is no conceivable national interest in talking down one of the key sectors which has contributed greatly to the nation’s wealth and stability over centuries.

35. But the banks’ contribution to wealth creation has to be soundly based and ethically robust. The activities of the financial sector have become too detached from the material reality which ultimately measures wealth, too driven by poorly managed borrowing and too vulnerable to theoretical risk assessment tools that place undue weight on mathematical probabilities and make insufficient allowance for the messiness of the human condition.

36. Redressing these imbalances and neglects is essentially a conceptual rather than a technical problem. Technical fixes, additional regulation and reformed structures may help but, as we have already suggested, the central task is to encourage and sustain a pervasive culture of banking which is framed within a concept of the virtues. Reliance on regulation alone will only lead to a frantic search for loopholes and a de-professionalising of the industry in a way which could diminish its capacity for innovation.

37. There is an important role here for the senior figures in banking who, so far, have not come out of the crisis at all well. As top bankers have been exposed to the public gaze (a hitherto rare experience) their capacity to speak of their activities in ways which connect to public disquiet has been found sadly wanting.

38. The public, as a result, now has little trust in such figures to overcome past structural failings let alone to engender the kind of new corporate culture which would act as a future safeguard. A new and humbler style of leadership will be necessary if the banks are to redeem their reputations.

39. As noted above, the differences between the regulatory regimes in different national economies within the developed world challenges the claim that globalization must lead to the detachment of banking from politics. A system of regulatory checks and balances is a matter for political decision, in discussion with, but not ruled by, the sector. The banking sector and the government should work together to evaluate the strengths and weaknesses of different regulatory regimes to see what lessons ought to be learned from other countries.

40. We hope that the Commission will give particular attention to the question of competition within the sector and, in particular, to ways forward which might restore the human scale of banking and rebuild relationships between banks and local communities.

41. When it comes to specific programmes for change, the devil is, as usual, in the detail and we are not qualified to promote any particular solutions or programmes as if they were self-evidently good.

Q6. Are the changes already proposed by (a) the Government, (b) regulators and (c) the industry sufficient? Respondents may wish to refer to the Financial Services Bill and the Government's proposals for the Banking Reform Bill.  They may also wish to refer to proposals by the Bank of England and the Financial Services Authority on how the Financial Policy Committee, Prudential Regulation Authority and Financial Conduct Authority will operate in practice.

42.
They are likely to help. But none of them appears to capture the sense in which the current crisis in banking is simultaneously a technical/economic and a moral/ethical crisis. This is not surprising since the capacity of any national institutions to speak cogently about ethics, virtues etc has been gravely diminished in the last 25 years or so. The banks have, to some extent, led the way in promoting the privileging of contracts over personal trust and the "creed of the bottom line" but they have been far from unique in this.

43. The opportunity now exists to embark on a major reorientation of a whole industry in an attempt to recapture an internal and external culture of "virtuous banking". By this we mean that the sector would operate to a set of, initially imposed but ultimately internalised, understandings of what it means to be a good bank. Such ideas are not communicated in rule books but by narratives and examples which communicate the nature of virtuous banking.

44. Perhaps this can best be communicated by a simple example. The philosopher Alasdair MacIntyre saw such virtuous practices embodied in the fishing fleets of the New England coast where each boat is a business in competition with each other. But when a boat gets into difficulties, the other boats think nothing of cutting their nets (at enormous financial cost) to go to the aid of the stricken crew. This is of course because of (a) the belief that human life is more precious than any possessions and (b) a recognition that mutual solidarity is an integral part of the common good.

45. A culture of the virtues is entirely consistent with a market economy which is pro-competition but it seeks to recognise that the ultimate "bottom line" is measured in terms of human, not financial, outcomes and that, in the end, every player is dependent not just on the law and regulation but on the ethical conduct of those with whom he is competing if his own work is to have sustainable outcomes.

46. The banking sector is a good deal more complex than the fishing sector. Nevertheless we offer the illustration to highlight the kind of culture shifts that we believe are necessary if banks are to avoid both a repetition of the hubristic failures of recent years and being smothered by excessive regulation that is more likely to cover backs than effectively promote the common good.

24 August 2012


[1] See: Peter Selby, Grace and Mortgage: the language of faith and the debt of the world , London : DLT: 1997 (reprinted 2008) for an accessible discussion of a Christian approach to questions of debt and money.

[2] See: Richard Sennett, The Corrosion of Character , New York and London : W W Norton, 1998.

[3] Rachel Jenkins, Changing Tim es: Unchanging Values? Manchester : The William Temple Foundation, 1991.

Prepared 22nd September 2012