In the wake of financial scandals, big banks declare their culture is changing, but critics say genuine reform is easier said than done
Sub-prime mortgages, predatory lending, complicity in money laundering, mis-selling of payment protection insurance, manipulation of interbank-lending rates, excessive charges, and the “London Whale”: since the roof fell in during the 2007-8 financial crisis, the charge sheet listing the banks' crimes and misdemeanours has just kept growing.
The sums involved are eye-watering. Jérôme Kerviel, for example, the former Société Générale trader, racked up €4.9bn in losses from unauthorised transactions by the time he was uncovered in 2008, dwarfing the £827m famously lost by Nick Leeson in the 1995 collapse of Barings Bank. The 2012 losses of JPMorgan Chase trader Bruno Iksil, aka the London Whale, amounted to $6.2bn. Payment Protection Insurance (PPI) mis-selling has so far cost the banks a staggering £22bn.
These losses and the fines levied on banks – such as the $1.5bn paid by UBS for manipulation of the Libor interbank lending rate – divert money that could be used to fulfil the basic role banks should be performing: keeping the wheels of the economy oiled through lending, in particular to small and medium-sized businesses that have the potential to grow and create jobs.
Banks are often accused of falling short in performing this less-glamorous but essential role. The UK Federation of Small Businesses (FSB), for example, in its first quarter 2014 Voice of Small Business Index, found that only one in five small firms considers credit to be “quite or very affordable”, though this does represent an improvement from the first quarter of 2013, when only 14% thought credit was affordable. Damningly for the banks, “the majority of small firms continue to find that the availability of credit is poor” and half rate loans as “unaffordable”, according to the FSB.
Something is clearly askew in the world of banking. Paul Moore, founder of risk consultants Moore, Carter & Associates, was previously the head of financial risk management for HBOS. He was dismissed by the bank in 2004 after raising concerns about excessive risk-taking and dubious sales practices. He subsequently became a vocal critic of bank behaviour. On small businesses, he says: “Banks don't lend properly to these markets.” The big British banks, he adds, prefer to sell profitable mortgages into the overheated housing market than to lend to small firms, which generally deposit more money than they borrow.
What to do with the money?
The basic question for banks in the post-crisis environment is what they should do with the money they collect from depositors. Should it be used to help business to invest and bring new products and services to market, thereby boosting growth and prosperity, or should it be used to maximise the banks' profits and the returns paid to shareholders?
Moore is clear on what the banks' answer is. Banking is still a “greedocracy”, he says. Continuing banking scandals show that “it's a dysfunctional system. The boards of directors [of banks] are so focused on short-term profit that they act both illegally and immorally.”
Moore reserves special fire for proprietary trading by banks – high-risk trading to generate vast profits, rather than commission-based trading for clients. “What's proprietary trading got to do with banking?” Moore asks. The practice is “rotten to the core”. He argues that, ultimately, bank traders do not risk their own capital but that of depositors and taxpayers, and that banks in effect profit from inside information – they are too close to the companies whose shares they trade in.
Backing for Moore's views comes from the US. The country has adopted the Volcker rule, part of the Dodd-Frank Wall Street Reform and Consumer Protection Act and named after former US Federal Reserve chairman Paul Volcker. Proprietary trading, according to the US Securities & Exchange Commission, leads to “unacceptable risks and saddled taxpayers with massive losses”.
The Volcker rule broadly prohibits banks in the US from carrying out proprietary trading, though there are exceptions. European regulators, however, have yet to follow suit. Moore says it would be a mistake to assume that the wave of post-crisis regulation and mea culpas from banks mean that the risks have diminished. Banks are a “powerful and wealthy lobby”, he says. They want to “carry on doing exactly the same as before”.
Banks, of course, are not deaf to the torrent of criticism. “The entire industry lost the trust and confidence of millions of people,” says Rob Watts, director of media relations at the British Bankers' Association. But change is underway, Watts says. “More than 90% of the executives who were in charge in the lead up to the financial crisis have gone. The idea of change is being taken seriously.”
A great deal of change is being forced on banks through legislation – such as the Volcker rule in the US. But another central plank of the reputation repair effort is culture change. This has been called for by no less a figure than governor of the Bank of England, Mark Carney, who said in August that banks must get back to the basics of lending to the real economy. If banking loses its focus on its utility role in favour of short-term profit seeking, it becomes “socially useless”, Carney said.
The big UK banks have revamped their strategies to emphasise culture change. Barclays has the “Transform” culture change programme, Lloyds is dedicated to “Helping Britain prosper” (see Box), the Royal Bank of Scotland (RBS) has said it wants to “serve customers well” and Clydesdale Bank's strategy is about “building relationships that last”.
The strategic reorientations all emphasise meeting the needs of business or private customers, offering more straightforward and clear products – RBS, part-nationalised since the financial crisis, for example says it will “stop confusing our customers with complicated language” – and ensure that banks play a more inclusive community role. In other words, banks claim to want to get back to the core business of banking, and away from excessive risk taking. RBS says its investment banking business will shrink, and will become something that “achieves acceptable returns” rather than stratospheric profits.
Encouragement for culture change in UK banking also comes from the Banking Standards Review. This was established by the main banks – Barclays, HSBC, Lloyds Banking Group,
RBS, Santander and Standard Chartered – in September 2013, in the wake of a Parliamentary Commission on Banking Standards, which recommended the creation of an institution to promote high professional standards in banking.
The outcome of the Banking Standards Review was a plan to create just such a body: a Banking Standards Review Council, which is intended to become operational at the end of 2014. The council, which banks will join voluntarily, will establish good practice standards – such as on handling small businesses that are in difficulty, or management of high-frequency trading – and get banks to report publicly on their culture-change and improvement programmes. Rob Watts of the BBA says the council will “improve professional standards across the industry and be a significant factor in rebuilding trust”.
Real culture change
Banks are making progress in becoming more socially useful, Watts adds. One sign of that is “the fact that we as taxpayers are starting to get our money back” from bailed-out banks. “No bank should have to be bailed out by the taxpayer ever again,” he says. Not everyone is convinced, however.
Dustin Seale, a partner in consultants Senn Delaney, which describes itself as “the culture-shaping firm”, says: “If the pressures were not on, would banks want to change? Probably not.” The culture-change programmes being put in place are sincere enough, Seale adds. But “neither the banks nor the regulator understands culture. They understand policy, regulation and remuneration. Senior teams in banking are doing a pretty good job of sponsoring culture change, but a pretty poor job of owning it.”
Barclays, for example, has redefined its values as “respect, integrity, service, excellence and stewardship”. Through its Transform programme, the bank says these will be “embedded into hiring, objective setting, performance assessment, reward and disciplinary procedures”. Pay will be linked to performance against values, and not just to financial returns for the bank. Oversight of the bank's activities will be tightened and will also be purpose- and values-driven.
But, says Seale, such a plan by itself is not enough. The banks' leaders “have to own it,” and “right from the top there needs to be personal change”. The suspicion at the moment is that banks are implementing change plans to manage reputational risk, not because they have undergone “an eye-opening experience of a different way of doing things”. Seale cautions that culture change “will not work if the top two levels of leadership are not displaying the characteristics of the culture they want”.
John Childress, an independent strategy advisor and author of 2013 book “Leverage: The CEO's Guide to Corporate Culture”, says one problem for bank management is that they do not necessarily know who the informal leaders are among their staff. For genuine culture change to happen, the “peer group pressure” that can be orchestrated by these informal leaders needs to be co-opted, but “most senior executives haven't got a clue who these people are”.
The recipe for culture change, Childress says, is “a new set of behaviours in leadership” combined with a plan to “identify, recruit and leverage those informal leaders who really run the sub-cultures” in the organisation. “Management thinks if they make a proclamation, everyone will change,” he adds, but a strategy for culture change needs to go much deeper.
The third element of culture change, according to Childress, is to identify bad behaviour and to change practices and processes as necessary – but again, it will be hard for senior management to really know what is going on if they have failed to identify the informal leaders. “You ask them to help,” Childress says, and as the informal leaders buy in to the culture change programme, “other people will listen”.
However, the challenge of culture change facing banking is daunting. “They just get to play with too much money that's not their own,” Childress says. Regulatory and structural changes – such as the real separation of retail and investment banking – are also likely to be needed to promote real change.
“So far nobody's made a really good case on the economic value of culture change,” Childress adds. The view prevails that more socially useful banking will necessarily be less-profitable banking. The arguments here are similar to those for and against environmental sustainability – on the one hand, that greater environmental protection will reduce economic growth, and on the other, that high levels of environmental protection result in sustainable value creation over the long run. Banks need to take on board the long-run perspective.”
Seale says the sector is not a hopeless case. “They're getting 60% right,” he says. Other “hard-nosed” industries, such as cars and aerospace, have made significant changes. Banks could do the same, though they must be aware that “firing often ends up being part of the deal” – the replacement of staff who are unable to change, or who no longer feel comfortable when the organisation changes.
Call for time
The BBA's Rob Watts says banks should be given time to change. In addition, the banks accept that it will “take time for their efforts to be recognised”. While he concedes that “people were rewarded for failure”, he points out that banking and finance is a major part of the economy, especially in the UK, and that a “flexible, competitive banking industry” will be a long-term benefit. “The industry hasn't necessarily communicated how useful it is for this country,” he says.
But former whistleblower Paul Moore says that a proper “independent forensic investigation” into the misdeeds of banking has still not been carried out. “You won't get proper change until such time as a proper investigation and enforcement is done.”
Fundamental changes to business models, rather than culture-change programmes, are needed he says. Changes could include prohibition of proprietary trading and a maximum recommended level of executive earnings – Moore suggests no more than 40 times the average salary in the bank. Without tougher external changes forced on banks, “they can talk culture as much as they like”, he says, but further financial crises will be “absolutely inevitable”.
Helping Britain prosper
Lloyds Banking Group is Britain's second-biggest bank by market capitalization. It has responded to the pressures on banks to get back to the basics of lending and serving local communities with the “Helping Britain prosper” plan, published in March 2014.
The plan contains seven commitments that emphasise the socially useful side of banking: helping people get on the housing ladder, helping customers plan and save, taking a lead in financial inclusion, helping business start-ups, mentoring businesses and entrepreneurs, bringing communities closer together, and better representing the diversity of customers.
Caroline McCarthy-Stout, head of Lloyds’ responsible business programme, says the bank's commitments will be assessed in the medium term, with a range of targets for 2017 and 2020. For example, the bank pledges to provide £1bn in new lending to manufacturers each year up to 2017, and to train more staff in how to work with social entrepreneurs. Lloyds will be “turning up the dial” in a number of key areas, McCarthy-Stout says.
She adds that the plan reflects the view of Lloyds chief executive António Horta-Osório that “responsible business shouldn't be separate”. Horta-Osório took over at the bank in 2011 and has been credited with getting it back on track after its 2008 taxpayer bailout. Thanks to board-level support, Lloyds is confident that the plan will be accepted throughout the bank. “What it's created is a framework that everyone can work to,” McCarthy-Stout says.
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