Can Financial Institutions and Markets after Deregulation be Ethical?

Content

Abstract

Introduction

Regulation of the financial institutions

CSR as a possible basis for building moral awareness

Examples of unethical behaviour in financial institutions

“Inside Job” a film that shows how unethical the finance world was and still is

What kind of ethics do financial markets and institutions need?

If not regulation or deregulation, than what can help?

Conclusion

Abstract

Financial deregulation was one of the key components that prepared the conditions for the economic crisis of 2007/2008. The environment in which financial markets and financial institutions have been operating led to a situation in which mortgage lending expanded, speculations grew and risk was constantly increasing. The risky financial transactions and the luck of moral compass of people working in finance led to the economic crisis in 2008. In this paper I will prove, that the deregulation preceding the economic crisis in 2008 had no impact on the ethics in financial institutions and markets, because ethics is not one of the most important factors in the financial world and that is more of a social then a regulatory problem. There is no other ethics then socially based ethics. Example: what is unacceptable corruption in some countries is a necessary step to win the contractor's trust in others.

Introduction

There is a contradiction between morality and ethics not only in business, but in other areas of life in our modern era. This is a normal situation for modernity, modern culture and modern institutions. On the one hand, we have rational, profit-oriented institutions, e.g. banks, on the other hand, moral people who are guided by moral principles in life, the source of which is tradition, school education, and religion. Often, the ethics of institutions (goals as good) are in conflict with the morality of the individual. Noticing this modern conflict (contradiction), great attention is paid to institutions dealing with professional ethics. In the discussion below I was trying to prove that regulation or deregulation are not the biggest problems that institutions dealing with ethics in business are facing.

Regulation of the financial institutions

Financial markets are heavily and closely regulated in minute detail. An excellent example is the UK, the Financial Services Authority (FSA) regulatory contains ten sections. The section entitled ‘Prudential Standards’ is divided into 11 subsections. The sub-section ‘Prudential Sourcebook for Banks, Building Societies and Investment Firms’ is made up of 14 sub-sub sections. The sub-sub section ‘Market Risk’ is divided into 11 sub-sub-sub sections. The sub-sub-sub section on ‘Interest Rate PRR’ is divided into 66 paragraphs. There are over 1,100,000 paragraphs in the rule book. Essentially, regulators are trying to do a job that cannot be done - closely regulate the investment banking system through detailed rules. This regulation has encouraged the creation of the new opaque financial instruments to get round regulatory systems. (Booth, 2010, p. 45) Regulation or deregulation people in business often act immorally, because they find themselves in a dilemma, and they solve it in a way that seems to be the least troublesome, deciding not to disclose information that could hurt their product. The consequences of what they chose to do - both to thousands of innocent people and, ultimately, to the corporation - probably never occur to them. (Chryssides & Kaler, 1993, p.68) They all know that their manager wants always the biggest profits, the best products, the quickest way for achieving set goals.

CSR as a possible basis for building moral awareness

The crisis has made everyone aware of the shortage of a number of ethical norms and continues to force us to seek new ways to improve the whole financial sector. The banking reality had to change after the crisis. Customers keep presenting bank with new challenges, as well as legal regulations at the state and European level. Many researchers say that CSR can be a solution for banks to built trust between the institution and the customer and that CSR activity can emphasize the professionalism of the institution.

The OECD defines Corporate Social Responsibility as ‘‘the common aim of the governments adhering to the Guidelines is to encourage the positive contributions that multinational enterprises can make to economics, environmental and social progress and to minimize the difficulties to which their various operations may give rise”. This is clearly seeing CSR as a move to increase the social value added by corporate activity. In financial sector CSR looks a little bit different. However financial intuitions can gain significant advantage in their basic business activity: insurance, loans and advisement, by incorporating rules of CSR in it. Criteria like corporate governance, treatment of staff and availability and sustainability of products play a role in assessments by rating agencies. This is why banks have been using CSR as part of their PR strategies as well as their overall business strategies. CSR is a concept, which in its core has a positive impact on the entire environment as well as on the organization. Certainly, many entities use CSR activities selflessly, gaining the benefits they deserve. This relationship is also used by entities that have noticed that it is profitable, often using other, also unethical tools under the banner of social responsibility. Such behavior destroys the image of the concept and raises suspicion towards all other organizations declaring CSR activities.

One can encounter many cases of using CSR as a "fig leaf covering real problems" or the desire to rehabilitate previously caused damage. One should think about whether, along with the action to repair the damage, there is a change in the company's conduct for the better? Companies inform about the transfer of a specific amount, percentage from the sale or organization of events with a noble cause. They take up difficult, important, but controversial topics (e.g. the topic of national minorities) less often.

Examples of unethical behaviour in financial institutions

One example of the financial institution that combines CSR with unethical behavior would be Wells Fargo. A very important area in which Well Fargo & Co implemented the CSR premises is risk management. The Environmental and Social Risk Management (ESRM) policy applies a coherent approach to understanding, assessing and integrating environmental and social risks in the decision-making process at every level of management and operations. (Murawski, 2018, p. 44) Every year Wells Fargo publishes a report on many other CSR activities that the company undertakes. However writing about Wells Fargo, in the ethics context, it is impossible to omit the fraud scandal. In September 2016 Fed charged Wells Fargo with a 185 million dollar fine for allegedly creating millions of fake accounts in name of their clients, without them knowing. After that all those clients of Wells Fargo had credit cards, checks and other accounts that were not visible to them. This episode led to huge downsizing in Wells Fargo (around 5000 employees were fired), and then the CEO – John Stumpf resigned from part of his pay and left the company in October.

Another example for unethical actions in financial sector would be U.S. Bancorp. Department of Justice accused the bank, that its program to reduce money laundering missed a big amount of suspicious transactions (2009 – 2014).

Banking scandals are occurring lately not only in the US. In Australia five of the biggest financial institutions were part of the scandal, that involved asking for money, for services they never provided. One of the most alarming allegation was that the institutions were charging their dead clients for advisement they “gave” them.

The above given examples are proving that after deregulation and the crisis there is still a lot of institutions that can easily find loopholes in the law and act unethically.

“Inside Job” a film that shows how unethical the finance world was and still is

The same conclusion was drawn in an Oscar-winning documentary "Inside Job" by Charles Ferguson. The film is an extremely sharp, solidly documented accusatory speech directed at political elites and the financial industry of the United States, which dismantled the banking system. Deregulation began under Reagan's rule in violation of a law that forbade savings banks to engage in investment activities. Corruption and financial crime have increased. Rigss Bank was laundering Pinochet's dirty money, Credit Suisse was transferring funds to Iran's nuclear program, Citibank took $ 100 million from Mexico. from drug trafficking. At the end of the 90s, securitization was invented, i.e. new speculative products combining mortgage loans with other loans, which were sold to investors as safe and secure, although they were not. Bankers' profits went into billions, greed grew. Stockbrokers played on Wall Street against their clients. Those who warned of imminent catastrophe were fired from work or deprived of bonuses. The ending, however, makes the biggest impression in the film. In 2009, when unemployment was the highest in 17 years, Morgan Stanley paid employees over $ 14 billion, and Goldman Sachs over $ 16 billion. In 2010, bonuses were even higher. The people responsible for the crisis received jobs in the Obama administration. So far, no criminal charges have been brought against anyone. No one was detained.

What kind of ethics do financial markets and institutions need?

The crisis shows that there is no sense in ethics, which is to "improve" people (the whole environment) through pedagogical activity, that is, educating, persuading, frightening with the consequences. This type of upbringing, i.e. socialization, is covered only at its early stages, through so-called significant others. It is worth trying to improve the moral condition of managers, because it is always better when people (whatever their profession) were more responsible, empathic and caring for the common good. But this “missionary” style of ethics triggers a defensive reaction and makes peoples actions not very successful. In addition, the call for ethical behavior in a world in which, to put it mildly, ethical behavior is not always rewarded, discourages acting on moral principles. Therefore, according to institutional ethics, one should not directly influence people's behavior, but change the rules so that honesty is not punished, i.e. an honest entrepreneur does not lose in relation to competitors. Good regulations mean that it is ethical to act in the interest of the individual and such behavior is rewarded with a competitive advantage. (Lütge, 2012, p. 14) Missionary bent assumes a specific set of moral norms that should be disseminated. The very concept of stakeholders implies the existence of fundamentally different points of view. Therefore, business ethics, when addressing people of interest, should point to dilemmas existing in society resulting from divergent interests of actors (so-called social actors) and propose systemic solutions that would not prioritize any of the groups. Ethics should teach how to recognize all relevant circumstances and sensitize the importance of a time dimension that can be relevant to the calculation of costs and benefits (short and long term). It should design institutional norms and solutions, moving from general to more detailed norms or, as Donaldson and Dunfee (1999) put it, from hypernorms to specific rules and procedures or microsocial contracts. What is important is the realism of this ethics, not formulating norms that would induce individuals to particular heroism and sacrifice, which would impose on them incredible obligations. (Appiah, 2008, p.186) This is particularly important in relation to activities based on economic rationality, including the maximization of benefits. This does not mean that moral norms cannot impose certain self-restrictions by economic entities, but they cannot be sacrifices that would contradict the basic logic of management. To say that business ethics strives to make business more moral is a dangerous mental shortcut. It is assumed that it is (can be) immoral and that the action of moralizing the economy is necessary, which always means moralizing specific people. If it turns out that this failed, the question arises, does this mean losing ethics? Or losing entire industries or professional environments? Apparently, to this day Michael Douglas gets “thank you’s” from young brokers who claim that thanks to his role in Wall Street they work there. Therefore, the task of business ethics is rather to promote certain patterns and reflect on moral norms in relation to economic activity. This requires a solid foundation of knowledge about mechanisms and relationships, for example political and cultural. It is therefore about ethics that can be called realistic, that is, not requiring heroism from people, not striving to make them saints, understanding that if ethical behavior puts entrepreneurs at a disadvantage, they will not follow certain rules - since others also they disregard them. It's similar with risk: if everyone is over-risking - without risking, I'm probably out of the game. Therefore, not taking risks can be an ethical risk. (Lütge, 2014, p. 6) Realistic ethics takes therefore into account the realities of managing in a competitive environment. This ethics does not encourage the realization of all values ​​desired by the society, but only those that enable mutual benefits in a competitive situation. These values have an immanent character, which makes business ethics minimal, limits it only to formulating rules for fair exchange, devoid of the aspiration to educate people and transform the whole world. It is about economic ethics or ethics of management, and it is the economy that ethics wants to serve by formulating norms regulating it. In this context, Norman Barry writes about arm's length morality: market participants usually do not know each other personally (compared to family members) and the only obligation they have is to respect the goals and aspirations of each party and the rules of exchange, that is economic principles of interaction. (Barry, 2000, p. 32) Thinking about business ethics after the experience of the latest crisis it is worth to refer to such its depictions as: minimalist and realistic in nature.

If not regulation or deregulation, than what can help?

Deregulation was one of factors that led to economic crisis, as well as unethical behavior was. A simple reasoning would be that a stricter regulation must be enforced and moral principles must be taught and then they must be followed collectively. While the first is easy and was made many times regulated then deregulated over and over again the second is much harder and seems that nothing changes, no matter what happens on financial markets. The terms we use and the concepts behind them make up a certain dictionary or language. If there is a claim that greed was the cause of the financial crisis, the language used does not allow to understand what really happened, because its concepts prevent it. The crisis has shown that the ethics of admonition, which would like to make entrepreneurs and managers more moral, and that ethics based on a kind of moral pedagogy are doomed to failure. Although this does not sound optimistic, people will not change just because they have been told what to do. Business ethics should not say "never again" as if it was possible to foresee the final shape of man. It is not business ethics’ task, in particular, to transform the "egoist" into an "altruist", the exploiter into a benefactor, because too many false assumptions are made here for example, that the market, competition, economy are areas of negative passions and the need to get rich at the expense of others is the most important of them all. As a result a certain assumptions that at the very beginning blame, judge and stigmatize - without contact with reality. In addition, today it is not possible to control people like feudal lords, there is no rewarding the servants, there is no small communities in which direct enforcement of morality would be possible. Instead, there is an endless conversation between autonomous and free individuals, whose opinions, thanks to this freedom, can often differ significantly. A regulation could be introduced that refers to improving the fate of everyone, which could be a kind of incentive to follow these rules (remembering that it is rather a task for general regulation rather than financial ones). In any case, the democratic process generates rules that serve everyone. However, precisely because they are the result of political discourse or compromise, they will never be perfect. And they will never be eternal. It is enough to trace the fate of the American Glass Steagal Act of 1933, separating banks' deposit and credit activities from investment banking, to see how the fate of legal regulations will change and how many factors will influence it: political, cultural and ordinary pressure of interest groups. The final repeal of the prohibitions formulated in this Act in 1999 (Gramm-Leach-Bliley Act) made under the slogan of modernization and opening the system to the challenges of the 21st century (cultural factor) enabled the creation of companies that simultaneously carried out commercial banking along with investment and insurance activities. (Guillén & Suárez, 2010, p. 267). Of course, it can be argued that this way the grenade, which was about to explode, was released of its safety lock, but another reflection is also possible: the democratic process looks like this, and its effects are always a compromise, which in addition does not have to last forever. Ethics in finance combined with economic thinking does not have to be ethics making compromises in favor of business on the basis of simple reasoning: in business we must be ruthless, greedy, selfish - because competition forces us to do it, but in the end such actions cause economic development that absolves us . The economic ethics postulated here are rather ethics aware of historical changes, systemic conditions, modern economy, the moral heritage of enlightenment and the impact of the democratic process on the shape of the economy, as well as its role in public discourse.

Conclusion

All in all, I think that the deregulation that led to crisis had no impact on how people behave. The business environment is such a very morally complex place. If employees want to keep their jobs simultaneously acting ethically it is nearly impossible. Financial intuitions and markets are facing the same dilemma when they want to keep their competitive advantage. Starting from a regular employee, through managers, to financial institutions and markets, it is not important whether they will be regulated or not, but what moral standards will be shown to them and ethical behavior will serve, on an equal footing: market advantage and social recognition.

References

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