By Megan Bowman & Elaine Byrne

Sydney: 24 April 2013

As noted on these pages last week the Australian Senate Economics References Committee delivered regulatory recommendations about Bankwest in its 2012 Post-GFC Banking Sector report that have ongoing relevance for the banking industry as a whole.

One of the Committee’s key recommendations was a voluntary code of conduct regarding bank lending to small businesses (SBs) to be developed by the ABA in consultation with SB representatives (Recommendation 9.1). This recommendation was a response to borrower allegations of mistreatment by Bankwest after loans were downwardly revalued and default proceedings initiated.

The recommendation is redolent of gradated interventionism. Specifically, the Committee opined that if banks want to avoid high interventionist measures then they need to first demonstrate proactive self-responsibility. The Committee accepted arguments by the major banks about the cost and burden of added regulation post-GFC; cautioning however that “if banks genuinely have these concerns, they have both the obligation and opportunity to demonstrate that the banking sector takes concerns about small business finance issues seriously and is willing to proactively develop a stronger self-regulated solution.” (par 9.6) The Committee was clear that failure by the ABA and the banks to acquit this task could trigger prescriptive government intervention.

The idea of gradated interventionism, particularly that developing one’s own standards can stave off more onerous ‘command and control’ government measures, is not new. Indeed, it is an approach often employed by groups of corporate actors in reaction to socio-environmental issues impacting on - or resulting from – business activities. This is well-documented in the corporate social responsibility and business strategy literatures, where seminal authors such as Michael Porter, Forest Reinhardt, and Andrew Hoffman have evidenced that getting ahead of the ‘green’ curve can have regulatory as well as commercial upsides.

However, the broader question raised by the Committee’s recommendation is whether self-regulatory solutions are still appropriate in a context of distrust. A clear but peripheral message from the inquiry was the high level of distrust by SB borrowers toward banks when they are left to their own devices. Indeed, it is likely that SBs will approach the ABA consultation with some cynicism or even hostility. This all begs the question: is trust an essential pre-requisite to the success of bank self-regulation?

Of all corporate sectors, the banking industry is particularly reliant on trust flowing from its stakeholders beyond just shareholders. This is because trust is the key to a bank’s ‘social license to operate’. As Leo Johnson of the Wall Street Journal explains: “Forget credit risk or legal risk. Let's look at the brand. What holds a great bank together? What is the one emotion you as the depositor must feel toward your bank? In a word, trust. When you give a bank your savings, you are putting your life in their hands. What's more, they are unverifiable; you can't kick the tires”.

Without trust, a bank’s business will quickly suffer, which can have dire consequences for such an inter-connected industry, as evidenced by the GFC. The potential result is a ripple-out effect from the banking industry to other industries that can weaken financial systems and thus whole economies. Mr Mark Carney, the new boss of the Bank of England and outgoing head of the Canadian central bank and Financial Stability Board, recently stated in the seventh annual Thomas d’Aquino lecture that: “Bonds of trust between banks and their depositors, clients, investors and regulators have been shaken by the mismanagement by banks… [such that] questions of competence have been supplanted by questions of conduct.”

Given that trust is so crucial to the operations of the banking industry, it is perhaps unsurprising that the interface between trust and organizational culture has received heightened scrutiny in the wake of the GFC.

Twenty-two percent of Americans surveyed in December 2012 for the Chicago Booth/Kellogg School Financial Trust Index say they trust the country’s financial system. This is down one percentage point since September 2012 – reflecting a decrease in trust of both the stock market and banks. 

Banks and financial services were the least trusted sectors across the globe according to figures released by the 2012 Edelman Trust barometer.  Just 52 per cent of informed publics and 49 per cent of the general population trust banks to do what is right. The figure is starker in Europe where less than one in three Europeans trusts banks or financial services.

Edelman attributes this lack of trust to both performance and behaviour. Developed economies rate bank performance much lower than emerging markets, giving the industry poor grades in its practice of lending to small businesses and providing home mortgage loans. “More than one in two people globally (56 percent) say they were aware of last year’s banking and financial services scandals with 59 percent saying the cause of those scandals was behavior, specifically corruption, poor corporate culture or conflicts with interest” Edelman concluded.

In his lecture, Mark Carney made a crucial point about regulating organizational culture in an attempt to rebuild trust: “virtue cannot be regulated”, he said, and “even the strongest supervision cannot guarantee good conduct”. In his opinion, the essential ingredient to rebuilding trust within bank organizations is “the rediscovery of core values, and ultimately this is a question of individual responsibility”. But that brings us back to self-regulation as a solution, which, as outlined above, may be inefficacious in a context where trust has already been eroded between stakeholders.

It is apparent that the regulatory conundrum created by the trust/culture intersection is quite dizzying. The Salz review, commissioned by Barclay’s in the immediate aftermath of the LIBOR settlements, is a case in point. The review sought to evaluate the bank's  “values, principles and standards of operation – the historical culture - and to make recommendations for change.” The importance of “culture” was given over-whelming priority with 424 references to “culture” within the 236 page review. 

The reputational impact of culture on public trust, and the global realization of its impact in the wake of the GFC, has warranted a refocus on organisational norms.