CSR in the Banking Industry
Held to account for creating shared value
“ Let us remember that if this financial crisis taught us anything, it is that we cannot have a thriving Wall Street while Main Street suffers. ” (Barack Obama, as cited in Decker & Sale, 2009, p. 135)
In the wake of the recent and still ongoing utterly devasting global financial crisis, both reputation and legitimacy of banks are highly under pressure. This situation is best demonstrated by the current protests in New York, generally known under the heading of ‘Occupy Wall Street’ (Krugman, 2011). The fact that the protestors’ claims are even generally acknowledged by leading economists, such as Nobel laureates Stiglitz and Krugman, and to some extent by Obama himself, shows how the financial crisis brought the banking industry and its contested practices dramatically into the public consciousness. It resulted in a massive erosion of trust and reputation in the industry. In terms of social responsibilitiy, this crisis showed that no other sector and profession has a “comparable ability to privatise gains and socialise losses” (Decker & Sale, 2009, p. 136). In order to address the current negative externalities of banks, such as social costs related to government bailouts, and the question of their crucial role in our economy and society, the concept of Corporate Social Responsibility (CSR) can serve as a helpful framework. Firstly, this essay aims to show the essential role finance, and thereby the banking industry, is playing in our economy. Afterwards, the results will be used in order to assess the potential relationship between finance and a more sustainable economy. The following section will analyse the potentials banks have to create shared value due to the crucial role of trust and reputation.
Banks’ crucial role in the economy
Finance1 is undoubtedly “grease to the economy” (Scholtens, 2006, p. 19). The banking sector has always played a crucial role in every capitalist economy and society. The industry operates the payment system, it represents an essential source of credit, and the sector is (supposed to be except in years of crisis) a safe harbor for deposits and assets (Hoepner & Wilson, 2010). Financial intermediaries add value through providing financial services to savers and investors. Four main functions of the banking sector can be identified: asset transformation, payment services, risk management and information processing, and monitoring of borrowers. In this sense, financial intermediaries act not only as agents who monitor and screen on behalf of the savers and investor. They are innovative themselves by offering products that mainly aim to cover risks, which is impossible for individual savers (Scholtens, 2006). King and Levine (1993) conclude, by providing statistical evidence, that there is a strong correlation between financial and economic development und thus supporting Schumpeter’s (1934) arguments of finannce’s role in the process of ‘creative destruction’.
Although their findings focus mainly on the link leading into the direction of positive development, the recent global economic trends serve as evidence that this relationship also holds true the other way round (Allen & Gale, 2008). Therefore, it is reasonable to state that finance directs our economy. By doing so, financial institutions shoulder huge responsibilities and it is worth questioning to what extent they can direct the economic development towards a more socially and environmentally sensible manner, and thus more sustainable. Figure 1 shows how finance and sustainable development can relate to each other. The possible transmission channels will be examined in the following section. As this figure from Scholtens (2006) has been slightly adapted by adding the requirement for an effective implementation of CSR2 into the operating processes at the firm level of the finance intermediaries itself (top arrow), a further explanation will be provided in section four.
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Figure 1: Relationship between finance and CSR
The possible link between finance and sustainable development
Most of the academic literature has identified three possible channels through which finance can help to achieve sustainable economic development at the macro-level: Kuznets curve, socially responsible investment, and stakeholder power. The environmental Kuznets curve describes the inverse U-shaped relationship between the economic growth (per capita GDP) and per capita environmental polution (Grossman and Krueger, 1995). As this trend can hardly be a concern of individuals, I will focus on the latter two transmission channels. Socially responsible investment (SRI) now accounts for $1 out of every $8 under professional management in the US (SIF, 2010). SRI funds are investments that are restricted by either simple bans on alcohol or tobacco companies or rules that guide investments by firms’ received ratings for their environmental and social performance from agencies such as Innovest. A rather sophisticated SRI fund allocates its investments into corporations by sector similar to the way that conventional funds do, but allocations within the sectors are guided not only by financial characteristics but also by non-financial characteristics, namely social and environmental concerns (Heal, 2005). Several empirical studies tried to compare the financial performance of SRI funds in comparison to conventional funds. While Scholtens’ (2006) literature review of these studies suggests that there is no significant difference between both investment types, other authors do find evidence that SRI outperform conventional funds. Heal (2005) concludes that, despite traditional theory suggesting that restrictions of portfolio choices lead to underperformance, there is some but not yet robust enough evidence that SRIs do have the potential to generally outperform competitor funds. According to him, CSR profiles of firms provide additional information, in contrast to the assumptions of the Capital Asset Pricing Model, most widely used in finance. CSR policies give an additional dimension of information to analysts and thus investment risks due to potential concerns from society can be better predicted. This fact helps to explain the correlation between superior environmental and economic performance. One of the most striking finding was provided by Kempf and Osthoff (2007). By following the simple trading strategy of buying stocks with high SRI rating and selling stocks with low SRI ratings, they obtained abnormal higher returns. As not much research has been conducted on the underlying reasons, promising answers are still to come as many authors expect the rapid growth of SRI funds to be continued, especially due to the growing adaption of institutional investors, such as pension funds and insurance companies (Sparkes & Cowton, 2004).
1 In this essay, finance and financial industry will be only referred to as the banking industry. For a discussion of CSR in the insurance industry, see Scholtens (2010).
2 CSR will be subsequently referred to as ‘the commitment of business to contribute to sustainable economic development, working with employees, their families, the local community and society at large to improve their quality of life’ (WBCSD, 2004).