To improve banking standards, bankers themselves must choose ethics over short-term profit
Norman Chan says while a sound regulatory regime is important, the best safeguard against yet another financial meltdown is for bankers themselves to choose to behave ethically
I was really encouraged by the implicit acceptance, in putting the thorny subject of ethical behaviour on the agenda of a banker's summit, that it is primarily for the banking industry to seek to regain the moral and ethical high ground it once enjoyed. This is not something which can, or should, be regarded as a "policing" or "enforcement" matter for the regulator. Getting caught out, taking the fine as a "cost of doing business" and moving on with making money is just not acceptable as a sustainable banking business model.
I do not subscribe to the view that banks' primary role is to generate maximum shareholder value, leaving the regulator to worry about the safety of deposits and the interests of the banks' customers. Having a licence or franchise to take deposits, which represent the hard-earned savings of millions of people, and use these funds for private gain is a privilege conferred by society on a bank, which merits exemplary professional and ethical behaviour.
The theme of the summit is "Regaining the moral and ethical high ground". What do we really mean here? I think, in a word: trust. With trust, comes respect.
In the past, banking was regarded as a reputable profession and bankers were highly trusted and respected. They no longer enjoy the same high degree of trust and respect from society, especially after the global financial crisis. What has changed so dramatically?
Well, the modality and governance structure of banking have changed a great deal over the last century. More importantly, these changes have created an incentive system that leads to a misalignment and disconnect between the interests of the owners of banks (that is, the shareholders), bank management and customers.
Not so very long ago, banking was a business conducted by individuals, families and (more latterly) private partnerships, where the owners and managers had ample "skin in the game". They stood to lose not only their investments but also their family wealth should their actions, or the actions of their partners, result in failure of their bank. This naturally served to temper the degree of exuberant risk-taking. This "alignment of interest" between bank owners or managers and customers and creditors clearly helped promote trust.
That said, many commercial banks have been structured as public joint stock banks with limited liability since the 19th century. So if limited liability has existed for 200 years, what else has been at work to create the problems which surfaced in the global financial crisis?
First, bank employees' time horizons have shifted. In the past, employees tended to be much more "stable" in the sense of their ties to a given employer. Nowadays, it is much more common for employees to hop from institution to institution to secure promotion or higher pay. In these circumstances, employees naturally identify less with the employing institution. They work at banks, not for banks. This is a two-way street, in the sense that banks, in their turn, can be very adept at severe downsizing if market conditions turn.
Business profiles and activities have also changed over time. Simple deposit-taking and lending businesses have been combined with investment banking, securities and capital markets, and even proprietary-trading activities, to form large, complex organisations, raising clear issues of cultural compatibility across businesses with very different objectives, time horizons and employee profiles. In an environment where near-term profits are highly prized and rewarded, it is all too easy to see how the more aggressive approaches introduced into the mix might prevail in shifting a culture from a client focus to one overly defined by financial performance.
Banks have also expanded from serving more limited numbers of wealthy customers to covering the mass market. Where once the local bank manager might have expected to know a significant number of his customers personally, now customer numbers are so large as to render relationship banking all but impossible. The result? Personal bonds are much weaker or indeed no longer created.
And what about their shareholders? The owners, now in the form of hundreds of thousands of shareholders, have only limited "skin in the game". Their personal or family wealth, outside of their bank shares, is not at stake if the bank fails. So their perspectives can now be much shorter term.
This mindset is more pronounced among some asset managers and hedge funds. As these asset managers are rewarded on the basis of the annual valuation of their funds' holdings, including bank shares, they have every incentive to push the banks to achieve higher profitability. So board directors and senior management were, and still are, under constant pressure to pursue higher return on equity. The result? Banks have no choice but to leverage up and take bigger risks.
So where do we go from here? While regulators clearly play an important role in influencing banking operations, it is really up to the industry to decide what it can and should do to regain the trust and respect that banks once enjoyed.
It is against this backdrop that the international community has sought to overhaul banking standards in the aftermath of the global financial crisis. While some bankers may think these reform measures represent a degree of overkill, the public sector firmly believes the current regime - in which bankers pocket huge bonuses in good times (or even in bad times) and the public sector, for fear of a systemic failure, comes to the rescue of troubled banks with a bailout using public funds - must not be allowed to continue.
So the choice is obvious. New regulations dealing with capital buffers, liquidity management, leverage, bankers' compensation, ring-fencing of deposit-taking business from riskier operations and so on have been introduced.
However, regulators and regulatory measures alone cannot possibly redress all of the problems. There is no substitute for internal governance and controls that are designed to achieve the desired behavioural change across the entire firm. In this context, it is crucial that we have buy-in from the owners, directors and management of the banks.
Banks need to promote the appropriate culture, values and practices across the firm, which are to put the safety of the bank and the interest of depositors and customers ahead of the banks' own commercial interests, just as bankers did in the past. Only when this happens will bank managers and employees change their mindset from "what can we get away with" to "what is the right thing to do". Only when this happens can the industry regain the trust and respect that bankers used to enjoy.
Norman Chan is chief executive of the Monetary Authority. This is an edited version of a speech he gave on Wednesday at the Asian Banker Summit in Hong Kong