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Communication 08 Apr 2016

Ethics in the financial system: a compliance system

Excerpt of the article published by Eduardo Arbizu, Head of Legal & Compliance at BBVA, in the Economic Studies Bulletin (“Boletín de Estudios Económicos”)  where he defends corporate culture (understood as formulating and putting into practice a series of values) as an essential component to ensure the proper functioning of the financial system from an ethical standpoint.

Ethics in the financial system: a compliance system

Ethics in the financial system: a compliance system

A significant percentage of the legal doctrine has pointed out that the recent financial has provided clear evidence of the moral shortcomings in the behavior of financial institutions and the weaknesses of their ethical principles. However, no author has delved deeper to identify the ethical foundations of the financial subjects whose behavior stood out positively, to draw examples for the future.

Taking this consideration as the starting point, in this article I describe the main meanings attached to the notion of ethics in the financial world to delve deeper into corporate culture, being the one with the broadest scope and meaning.

This requires both formulating and implementing a series of values, by means of a system where the top management’s example, company-wide engagement and the rollout of procedures that ensure its effectiveness become essential elements.

The financial crisis as an ethical crisis?

Ethics in the financial system is one of the most recurring topics in business ethics. For a significant amount of authors and for the public opinion, one of the key elements that originated the crisis was the concurrence of unethical behaviors from the key players in the financial systems.

What differentiates the study of ethics in the financial sector is how significant the financial function is for the development of a free-market economy and which is founded on a relationship of trust that justifies the regulatory intensity, the strict supervision and public intervention when the market fails.

For a significant portion of the authors, the financial crisis has revealed the existence of relevant failures in the ethical behavior of financial institutions, and their executives and employees. Many times, these failures are extrapolated with no actual basis to the sector as a whole. A punishment that's equivalent to “stripping the financial world of any form of social recognition” is being promoted. Other authors, however, do not believe that the crisis was triggered by behaviors that were specifically unethical.

Neither the authors that attribute the crisis to a moral failure, nor those that believe that the crisis was essentially caused by regulatory or supervisory failures, have devoted sufficient time to objectively analyze the behavior of certain financial institutions that did not react in the same manner to the incentives that originated the crisis. Because the truth is that certain institutions did not adopt the irresponsible risk management practices or inadequate capital or liquidity procedures that led to the crisis.

The crisis was, first and foremost, a failure in the management, motivation and behavior of people. The institutions that managed to adopt more resilient corporate cultures were able to withstand the crisis without failing to meet their social purpose or having to resort to public assistance to do so.

At a worldwide level, it is a verifiable fact that commercial banks have not been hit as hard by the crisis as investment banks. Likewise, universal banks have fared much better than highly specialized banks. Within the Spanish boundaries, banks have not engaged in the same practices nor required the same level of support as savings banks have.

However, the public debate over the behavior of financial institutions from an ethical perspective seems to be lacking the serenity required to distinguish what was appropriate behavior from what was not.

Nevertheless, through empirical observation it is possible to pinpoint notable behavioral, responsibility-related and cultural differences which are worth analyzing if what we want to do is find the right solutions and adopt regulatory, legislative and judiciary decisions oriented towards the achievement of the common good in the medium term.

Ethics in the financial system: a compliance system

Different meanings of financial ethics:

A)    Ethics as the fulfillment of a professional function

An ethical behavior would be a professional, diligent and responsible behavior within the main purpose of the financial activity. Simply put, doing a good job, managing risks professionally, and promoting the legitimate profitability of the investment of the bank’s shareholders. This is the most useful concept when it comes to assessing ethical behavior in the financial sector.

B)  Ethics as corporate social responsibility

The company’s response to society, which abides by a series of voluntarily pre-established commitments by virtue of a moral judgment.

The approach of financial institutions is quite similar to the one that other industries follow, with social, environmental, cultural and sponsorship programs. There are, however, sector-specific initiatives, one of the most notable being the “Principles of Ecuador”, adopted in 2003, when 10 banks pledged to apply the social and environmental policies and follow a project funding analysis procedure and their review by independent experts.  BBVA was the first Spanish bank to join this initiative in 2004.

C)   "Ethical banking"

Ethical banks are those that lend or invest money seeking an ethical purpose, choosing investments based not only on profit-related criteria, but also on the social concerns of its account holders.

These initiatives, due to their purpose and dimension, leave out the vast majority of the financial activity, which has to be covered by professionals that both are required to behave ethically and recognized for said ethical behavior.

The option of the so-called “ethical banking” is, considering the purposes it seeks to achieve, undoubtedly praiseworthy. Nonetheless, it is not the only ethical conduct that takes place within the financial activity, nor is it justified to claim exclusive ownership over the epithet.

D)   The ethical dimension of the microfinance activity:

Development of the financial activity as a transformation element of society. Aimed especially at people with less resources and limited access to the traditional financial activity, providing them with a social integration tool through credit.

The progressive adoption of a commercial approach to microfinance, together with the disproportionate growth of some of them, have raised questions regarding the ethical dimension of these institutions.

The debate strengthens the idea that ethical behavior cannot be determined based on the goals pursued, but on the effective culture and conduct that govern the activities carried out to pursue them.

Financial ethics as a culture of compliance

Among all the possible meanings of financial ethics, the one that has a broader practical application is the one that understands it as a responsible professional behavior. In this senses, an ethical financial institution will be an institution that has managed to ensure that its leaders and employees perform their duties in accordance with a corporate culture with pre-determined moral values.

Is there room for ethics in financial regulations?

As discussed above, recent scandals have evidenced the distance between the values stated in the codes of conduct and the ones that employees actually implement and live by.

Based on these failures, some authors have questioned the effectiveness of the ethical principles when it comes to regulating conducts in the financial sector, defending regulations as the only solution to guarantee the correct running order of the system.

Other authors, however, consider that it would be extraordinarily hard to articulate legal rules capable of cover the whole universe of potential future situations in the sector. Legal regulations are rigid and inflexible. On many occasions, their content is excessively detailed, but insufficiently on many other.

Notwithstanding the obvious need for regulations to establish the minimum requirements, it is inevitable to share the skepticism regarding the practical effectiveness of these measures and the negative consequences that an excessively thorough or strict regulation can bring in connection with the future access of customers to products and services.

An effective corporate culture

If we accept that the mere statement of values is not enough, we will need to deepen into the factors that determine the success of some organizational cultures compared to other.

The statement of ethical values in the codes of conduct will be of very little value a company’s symbols do not convey them. The practice that is really learnt is the one that leads to recognition, remuneration and progress in the scale of merit of the organization.

Therefore, an effective implementation of the values requires rolling out an internal regulation aimed at the design of processes that generate and maintain behavioral habits, in a way such that they are integrated into the institution’s behaviors as some kind of metaregulation.

This process-oriented regulation needs to be: (I) easily perceptible (II) sufficiently disseminated and (III) effectively applied through remuneration, recognition and sanctioning mechanisms.

The corporate culture is critical to ensure honesty and integrity in employee behavior. Its effectiveness depends on a series of factors:

  1. The top management’s commitment and example. If those who bear the highest responsibility behave inadequately, they can neither expect nor require their collaborators to apply different integrity standards.
  2. Integral involvement of the company: Commitment with the integrity values has to affect all the people that integrate company, and all the activities that the company develops.
  3. The rollout of a compliance program, through the approval of policies and procedures aimed specifically at the effective application of the values.