Banking StandardsWritten evidence from the Ecumenical Council for Corporate Responsibility

LEARNING TO TRUST: REBUILDING A BROKEN CULTURE

1. Introduction

The Ecumenical Council for Corporate Responsibility is a faith based member and investor coalition which works with religious investors in the UK and Ireland to promote corporate responsibility within the companies in which members invest. Membership spans all the major denominations and includes major church bodies, church related organisations, religious orders and congregations. There are approximately 85 corporate members who control and influence over £10 billion of assets.1

2. ECCR’s Christian Perspective

Christians accept the responsibility to work for a society marked by justice, compassion, peace and environmental stewardship. This requires us to stand in solidarity with all people oppressed by poverty and exploitation and to work to change the structures, policies and practices that harm them and the natural world on which human life depends. As banks are a key economic intermediary, consideration of their activities must therefore inform our scrutiny of what makes a good society.

2.1. Christian groups deploy significant funds as investors and have a specific responsibility to use those funds ethically. In 2011, to help inform investment decisions made by our members we produced a report on the banking sector—The Banks and Society: Rebuilding Trust2. Since then there have been all sorts of developments—the Libor scandal, money laundering scandals, more debates about banking remuneration structure, and a growing awareness of the need for a cultural change. There are currently no “untainted banks” for investors to invest in and few for consumers to use. Moving an account for a more ethical option is a choice of greys. More than ever before there is a need for a new compact in our society, for relationships based on trust as well as regulation. ECCR has no wish to repeat what it has said before, but there are new points to make in the current debate and ECCR has a view about the need for cultural change that it wants to share.

2.2. Banks act as a place to store money and a source of funds for investment; they offer advice and facilitate transactions ranging from everyday purchases to international trade. By the way they react to changing economic policy they can influence the growth of the money supply and the effects of actions taken by central regulators. The relationship between banks and society should be mutually beneficial and based on trust. When Bob Diamond at Barclays referred to the need to create “a culture of integrity and trust” he was right, and pilloried for not being seen as an exemplar. Trust has been seriously eroded by the current economic and financial crisis, for which many hold the banks largely responsible.

2.3. In this submission we focus on:

Banks’ role as intermediaries in society.

Codes of conduct and building a culture of morality.

Banks’ social and environmental impact.

The need for transparency and better reporting.

Corporate governance and the ethics of risk management.

Remuneration.

3. Banks as Intermediaries in Society

Economic stability ultimately requires social and environmental sustainability. Banks can both contribute to and help find solutions to a range of social and environmental problems. Amid discussions about how the banking system can be made “fit for purpose”, we therefore need to take account of environmental and social issues, including human rights issues. We consider that these issues have received insufficient attention in debates about banking reform to date.3

3.1. The primary task facing banks and regulators is to restore a financial system in which society can trust. Such a system must effectively manage risk, be financially sound, fully serve the needs of society and intelligently address concerns about injustice, inequality and the environment. While they cannot be held responsible for the actions of their customers and clients, banks have a responsibility to ensure as far as possible that their products and services enhance rather than undermine human rights, environmental sustainability and the public good. This is a responsibility common to all “organs of society”. Banks should not be involved in illegal activities or in activities likely to lead to illegal or immoral actions, or which are exploitative or designed to undermine the social contract with society. Due diligence is key.

4. Codes of Conduct and Building a Culture of Morality

The various scandals over bad lending, rigging rates, mis-selling products, money-laundering, or excessive remuneration packages, have all highlighted that morality matters. A compact of trust in society is not based just on laws, regulations and effective supervision. It requires trust in those being entrusted with responsibility for people’s money—as savers, as investors, as movers of cash, as taxpayers, as employers. It is not enough that regulators can impose fines and punishments; if banks are to regain their reputation they must prove themselves trustworthy. That requires a moral stance, a culture that says everyone in the bank should be listening to their inner voices of self-restraint, should be knowing when not to do something even if thought to be legal, and even if it may not be found out. It requires every employee to know what is right and what is wrong, when customers’ and owners’ interests are being subordinated to personal gain. It requires knowing what is dishonourable and untrustworthy.

4.1. In a largely secular society traditional moral codes of conduct cannot necessarily be relied upon. The underpinnings of fear of a power beyond knowing are not there. It is, however, not sufficient to put in place a rule based culture of box ticking to create a moral correctness that is not instinctive.

4.2. A belief that free-markets will turn everyone’s pursuit of self-interest into the greater good is nonsense. Economic decisions depend on how the decisions are perceived and how intermediaries respond to those decisions; they do not have quantitatively predictable responses as in maths or physics. The key component in making a market work is trust; the old city maxim of “my word is my bond” recognised this.

4.3. Behavioural economists have noted that most people are willing to cheat, given the temptation and opportunity, just a little, enough to feel we are not being dishonest. The “fudge factor” means we all want to benefit from cheating but view ourselves as honourable and honest. People are more likely to cheat when tired or stressed, when they have financial incentives to do so, where the morality is unclear. Such dishonesty is contagious; if some are doing it, others will try. If there is a belief that colleagues will benefit, even the best can make a wrong call—the Libor rate-fixing scandal was done to preserve the system as much as for gain.

4.4. Changing a culture requires not just the existence of a code of conduct but the belief of the individuals within a company that they will be held to that code, that it will be enforced as a term of employment. More than any other sector, the banks need to introduce such certainty. So many transactions are lacking in transparency; so often practices have been condoned to make the most of an opportunity for profit rather than to maximise customer service (the time it takes to clear cheques, for example). If banks are to regain a position of trust and respect they require a cultural change—an emphasis on the virtues of self-restraint, of service to customers and owners, of trustworthiness. Until a cultural change is embedded, regulators will just be fighting fires.

4.5. The complexity of financial reporting, and of the products offered by financial institutions (not just banks) means that such institutions must develop as part of their culture of compliance with corporate codes, a climate where “whistle-blowers” are welcomed and rewarded. From an early age children are taught loyalty to peers and not to tell tales on their siblings or mates. Such a culture is not acceptable in banks or other corporate environments. If an employee perceives another’s action as not being in accordance with the corporate code, she or he must say so. Fundamental to this is a clear statement of the code and training in its implications. In the US a recent well publicized case resulted in Glaxo SmithKline having to pay $3bn of fines to US regulators for illegal bribing of doctors; more than $150m went to four whistle-blowers, GSK executives, who reported the company to US authorities. The legal basis for this is “qui tam” a 13th century English law that gave private citizens a share of fines levied on taxpayer evasion. Abolished in the UK in the 1950s, the practice in the US has helped recover $27bn for taxpayers over the last 25 years. Why should British regulators and companies not adopt similar incentives? Compliance with a code is helped by people believing their non-compliance will be frowned on and punished. There is a strong argument for rewarding those who highlight wrongdoing that causes financial or reputational damage, as well as punishing the wrong-doers. The FSA and Bank of England should require such incentives for self-monitoring as preferable to more expensive, and less effective, external oversight.

4.6. This need for cultural change does not apply solely to banks. 42% of the public do not believe that British businesses behave ethically and fewer than a third would trust a business leader to speak the truth (Institute of Business Ethics). If every employee of a bank is to be held to that company’s values, then banks must make a commitment to training staff as well as to having codes of conduct. Many companies are beginning this journey—Arcelor Mittal has given all its employees all over the world training in how to recognise human trafficking, the mining companies have sought to establish industry-wide standards against corruption in response to the Bribery Act proposals.

4.7. If this process is to continue then stock-markets must look beyond the next quarter’s figures. Marks and Spencer launched their “Plan A” setting out 100 ethical and sustainability targets which they held to in spite of City criticism. Regulation is an essential basis for good conduct but it is only the start. Bankers crusading against regulation are often eroding trust.

5. Social and Environmental Impact of Lending

There is a powerful business case for banks to take full account of social and environmental issues in their lending decisions. In the long term, no business sector or individual company can thrive while doing harm, yet our research found many examples of banks financing projects or companies associated with environmental damage, the abuse of human rights or which have a negative effect on local communities. Banks arguably have a far larger impact on society and upon the environment as an indirect consequence of their lending decisions than through their day to day activities over which they have direct control.

5.1 As demand for ethical and sustainable investment products continues to grow, ethical banking will surely follow as the logical next step. Better integration of social, ethical and environmental issues is also important for banks’ risk management. Businesses are increasingly susceptible to the reputational impact of media and civil society revelations about negative behaviour. Barclays withdrawal from selling tax avoidance products on grounds of reputational risk is an initial recognition of this fact. The financial backers of the corrupt, or those exploiting natural resources badly, or those seeking personal gain at the expense of those they should serve, should be held to account for the actions of those they have backed.

5.2. Why should any bank not espouse the values of the Global Alliance for Banking Values (GABV)? This network of 13 banks serves close to 10 million customers in 24 countries and has a combined balance sheet of over $26 billion. It has pledged to raise over $250 million in new capital and to “To touch the lives of a billion people with sustainable banking by 2020”. Member banks commit to: use money as a tool for enhancing the quality of life through human, social, cultural and environmental development; take responsibility for their long term impacts on the environment and society and show transparency, trust, clarity, and inclusiveness in delivering products and services.

5.3. GABV lending supports renewable energy and affordable housing projects, small business expansion, micro-credit for the poorest communities in developing countries, and co-operative and civil society organisations.4

5.4. A range of tools are increasingly available to help potential customers choose a bank that most closely reflects their values. However, whereas all companies including banks must conform to strict rules about how they present financial information, and increasingly face more prescriptive guidelines on the disclosure of corporate governance information, there are few firm rules when it comes to issues primarily of social, ethical or environmental concern.

6. Transparency

Transparency is important for any business, and banks are no exception. It enhances accountability to shareholders, customers, employees, local communities and others. It enables shareholders to assess the extent to which the company is exposed to or is managing risk, enabling a better view of the business’s prospects, and hence informing shareholders’ investment strategies and their dialogue with company management.

6.1. For society generally, corporate transparency means better knowledge about companies’ policies on matters of concern, to allay fears and misunderstandings and encourage trust. Transparency allows a proper conversation with stakeholders affected by company decisions which can benefit both company and community. By being open about their policies and activities, companies are also more likely to earn the respect of employees and customers. On the other hand, a perceived lack of transparency is likely to lead to negative perceptions, even if in reality a company has nothing to hide.

6.2. For stakeholders to have confidence that banks take ethics into account when lending or providing other financial services, banks need to be transparent about their policies and how they implement them. Banks should disclose all the policies they apply to decisions about lending, asset management and their other business services, as well as providing information on all corporate and government financing deals. ECCR would also like to see greater transparency about how banks are responding to challenges such as developing country debt, money laundering and tax avoidance—about which currently very little is said.

6.3. Most UK banks publish separate corporate responsibility reports and maintain websites providing information about their social and environmental impact. However, the type, quantity and quality of information—and the extent to which the information is independently verified—varies considerably. Banks generally provide more information on their direct activities—such as how they are working to be a good employer or how they are seeking to reduce the environmental impact of their branch networks, rather than the indirect, but potentially more significant social and environmental impact of their lending decisions. Yet, even those that use the Global Reporting Initiative (GRI) financial services sector guidelines as a basis for their reports5 often fail to provide sufficient information to answer many of the questions society is entitled to ask. There is an urgent need to address this information gap.

6.4. With regard to lending, some banks—including Barclays, the Co-operative, HSBC and Standard Chartered—publish or make available on request all the policies they apply to lending decisions. Others still fail to do this. As to transparency about individual financing deals, despite the occasional case study, no UK or Irish banks other than Triodos provide detailed or systematic information about the companies they lend to or arrange financing for. Royal Bank of Scotland recently published a breakdown of its financing to the energy sector and promised enhanced disclosure in years to come, but this remains the exception.

6.5. Because of the Equator Principles6 (EPs), transparency tends to be better around project financing, though disclosure still remains at an aggregate level categorised by risk, industrial sector or geographical region. Some banks provide information about the number of deals declined under the EPs but generally without enough context to enable stakeholders to understand why.

6.6. Banks often cite commercial and client confidentiality as a reason for a lack of “deal transparency”. When social and ethical issues are involved such confidentiality is not the over-riding issue. Banks could make a greater commitment to transparency by stipulating in credit contracts that the names of corporate clients will be published. This approach is taken by Triodos, which publishes basic details of its commercial borrowers on its website.

6.7. Few banks with asset management divisions, even among United Nations Principles for Responsible Investment (UNPRI) signatories7, publish detailed information about their socially responsible investment policies or how they put these into practice, either for mainstream funds or for designated “ethical” funds. HSBC, for example, provides an overview of the social and ethical issues it considers as part of asset management decisions and the principles guiding its engagement with companies in which it invests; yet it does not publish all of its policies or give examples of how it has engaged with the companies in which it invests. Other UNPRI signatories such as Irish Life Managers and Scottish Widows do not even provide this. Of the banks we have surveyed, Co-operative Asset Management is notable not only for publishing the policies underpinning its investments but for providing detailed information on how these are implemented and how it has sought to influence investee companies. ECCR considers that all banks with asset management divisions should follow this example.

6.8. Banks also need to be transparent to show that they are not party to the handling of the proceeds of crime. Their unique role on managing financial flows gives them a vantage point from which to see where money is derived from and for what it is being applied. Traffickers in drugs and people, perpetrators of financial frauds, thieves and rogues of all sorts use the banking system to move the proceeds of their crimes—yet there have been many examples of banks failing to spot this or reporting their concurs to the relevant authorities. There should be a positive recognition of the duty to report illegal activity and to assist law enforcement that trumps the duty of client confidentiality.

7. Corporate Governance and the Ethics of Risk Management

The Banks and Society showed how banks corporate governance, risk management and their impacts on the societies they serve are inextricably linked.

7.1. Banks, like all businesses have to manage risk in their own interests and those of their employees and shareholders. Yet effective corporate risk management is widely viewed as a technical issue and rarely considered to be an “ethical” concern. Is it different for banks?

7.2. ECCR considers that it is. Banks occupy a privileged place in society. With a reputation for good judgment and prudence, a bank has been trusted as a safe place to deposit money, a responsible lender and a source of good financial advice. Such trust, in part based on a reputation for managing risk, has been good for business and contributed to banks’ success. For many, the fact that banks have so spectacularly failed to manage risk is a major breach of that trust.

7.3. Furthermore, banks are not ordinary companies. Not only are they central to the functioning of any economy, they also enjoy an implicit—and recently explicit—subsidy from the public purse. This comes in the form of depositor protection schemes and the strong probability that the most systemically significant banks will receive government bailouts in the event of failure. The largest banks were deemed “too big to fail”. When they did fail, there were repercussions for almost all of humanity. Bailing out the banks has cost taxpayers worldwide trillions of pounds and resulted in huge government deficits and subsequent cuts in public spending. The global recession that followed has thrown millions out of work, and stopped the creation of new jobs for millions more joining the employment market, with a disproportionate effect on the poor and vulnerable. This situation, whereby the benefits associated with banking are privatised (enjoyed largely by senior employees and shareholders) but the risks of imprudent behaviour are socialised (transferred to the general public), is part of the “moral hazard”, long the subject of economists’ debates, and the avoidance of which is central to rebuilding trust.

7.4. In addition, because of banks’ interconnectedness through inter-bank lending, the sector is particularly susceptible to “contagion”. Failure or fear of failure of one major bank can start a landslide, and this high-consequence systemic occurrence was only narrowly averted. While limiting such systemic risk has primarily been seen an issue for regulators. Banks must identify, and be accountable for, risks they introduce to the financial system and must apply the precautionary principle to all potentially risk-prone activities.

7.5. Dissecting how and why the banks failed to anticipate and manage key risks has been the subject of an immense amount of discussion. While regulators, shareholders, auditors and credit rating agencies have all been criticised, banks’ own boards of directors played a central role in the collapse. Many boards based their risk management strategies on what turned out to be unrealistic assumptions about continued economic growth, or continuing growth in value of a particular asset class (eg residential or commercial property) regardless of wider factors. Many board members simply failed to understand some of the more complex products and deals in which their banks were involved or the risks they posed. The UK Treasury Committee highlighted a failure to understand risks posed by the securitisation of mortgages, widely but falsely believed to be a method of dispersing and managing risk.

7.6. A critical factor was over-reliance on quantitative risk management techniques and mathematical modelling. While required by regulators, these do not take into account social factors that can have major financial risk implications—for example, the widespread mis-selling of mortgages and other financial products to people who could not afford to repay them or did not need them. Over reliance on quantitative, depersonalised systems can result in a collective abdication of responsibility and a failure of financiers to accept the need for individual responsibility for failures of judgement and a failure to act to prevent harm. There is a strong argument for reverting to more lending decisions being taken locally and regionally on the basis of managers’ personal knowledge of companies and other customers rather than total reliance on centralised computer scoring. The example of Handelsbank8 is worth close examination.

7.7. Many banks have treated risk management primarily as a compliance issue and to meet regulatory requirements rather than actively anticipating and seeking to control risks. The result was a poor risk management culture and a tendency to view risk management as getting in the way of banks’ ability to undertake what they saw as attractive business.

7.8. In the UK the 2009 Walker Review of corporate governance and the House of Commons Treasury Committee both emphasised the need for a stronger, independent risk management function within banks, with the latter recommending board level risk committees. Most banks that did not previously have such arrangements have since put them in place and now make an annual report to shareholders on risk strategy and management.

7.9. The importance of non-executive directors (NEDs) is key. Their function is to act as a balance to the executive members in risk management. There appears to be a general consensus that the cadre of NEDs on any board needs to encompass individuals with sufficient specialist background to grapple with banking and risk matters in challenging executives. However, ECCR shares the Treasury Committee’s concerns that NEDs are drawn from too narrow a pool and that banks need to widen their search to encompass others with broader experience and different world views. NEDs need to commit sufficient time to perform the role well and there is a good case for them to limit their other roles such as trusteeships or directorships to ensure this.

7.10. Important as structural reforms are, banks need to go beyond the regulatory minimum and have a culture of diligent risk management right across the business. This will require longer term cultural change. The test is likely to come if and when markets recover and memories of the “credit crunch” start to fade. For such cultural change to become embedded there must be created in each bank a code of corporate governance and a training system that makes sure all employees are thinking about the moral issues involved when making their lending judgements. Compliance with the code must be understood to be a condition of employment, with individuals who cause loss and cannot show they have complied, being removed from their jobs. A money maker who cannot live in accordance with the bank’s value system cannot keep his job.

8. Remuneration

In recent years the word “culture” has too often been linked to pay—”bonus culture”, “culture of greed”. The challenge banks face is to decouple the word and define their culture by good behaviour and the trustworthiness of their banks to clients, shareholders and society at large. Part, a painful part, of that process is going to involve normalising bankers’ pay and bonuses. The idea that an individual, taking large risks with another’s money, can reap substantial reward for himself regardless of whether he ultimately loses the principal’s money, does not bear any close examination. In the Lloyd’s of London insurance market it was once normal for agents to receive profit commission on any profits made but bear no loss if their judgement calls caused loss to those they acted for (Names). In most companies profits can be manipulated in the short-term. Arrangements to distribute profits but not losses to employees are therefore recipes for disaster. Lloyd’s stopped such arrangements in the eighties (though not their arcane accounting rules), why have the banks not learnt the lessons thirty years later?

8.1. Even before the financial crisis, some had questioned bank remuneration structures. Many governments, including those of EU states and the USA, have accepted the need to reform remuneration structures, and countries including the UK have started to act on this. Further changes are expected at the EU level, and remuneration continues to be under review internationally.

8.2. Income inequality in society is now an increasing problem. Income inequality in the USA means that the proportion of the national income going to the richest 1% tripled from 8% in the 1970s to 24% in the 2007. Such growth in inequality fuels social instability as is currently being seen across the globe from the US to China. There is a backlash developing to the growth of such inequality. As global citizens banks should be aware of this and be at the forefront of curtailing the excesses that have led to it. There is little evidence to date that the banks are succeeding in this task. In 2009 the UK Treasury Select Committee heard that a chief executive of one of the larger UK banks would typically have an annual salary of between £1 million and £1.25 million with perhaps four times as much in bonuses share options and pension and other benefits. In investment banks and investment banking arms of retail banks the total remuneration of senior executives could have been even higher. At the same time many banks have faced campaigns calling for them to pay all who work on their premises a living wage.

8.3. Much has been written about the extent to which bank remuneration structures were responsible for the financial crisis. Most commentators agree that—particularly in investment banking, remuneration packages gave incentives that were not aligned with the long term interests of shareholders. Bonuses were in some cases paid out in cash as soon as a deal was completed or based on a bank’s revenue for a single year and thus caused particular problems. Some bonuses were paid with little regard to whether a deal would be successful in the long term or whether overall profit levels were sustainable. All this contributed to excessive risk taking and promoted short term thinking rather than an emphasis on longer term returns. Performance and Reward, by ECCR member Patrick Gerard9, delineates the corrosive nature of “bonus culture” on overall business culture and practice. Remuneration structures, and particularly the bonus elements of these, need to be much more closely aligned to long term performance and shareholder value.

8.4. Belatedly shareholders are now taking action to challenge excessive pay awards. However, replacing large bonuses with even larger salaries, is not an answer, increasing, as it does, fixed costs. Banking is undoubtedly a field where employee individual efforts and flair can make exceptional profits and losses. Those with the flair feel they deserve a substantial share of that profit. They cannot make any profit, however, without the capital and platform of their employer. That platform must be sustainable without public subsidy. The logic is that bonuses must reflect long-term performance, and be able to be clawed back if the activities, profitable in the short-term, generate losses. This requires transparency about the way bonuses are calculated and the matching of deals with profits and losses over time—often considerable periods of time.

8.5. In this connection banks must pay particular attention to the way profits are calculated. Profits have always been capable of manipulation. Manufacturing companies can adjust them by stock valuations or treatment of overhead expenses, financial companies can adjust them by the purchasing of reinsurance or financial derivatives. Over the last decade such manipulation of profits has grown more widespread. Research has compared aggregate earnings per share reported by large US companies with the profits section of the US National Income and Product Account (part of the calculation of GDP). In any one year these figures might differ marginally but over a century they were in broad correlation; in the last decade they have diverged. Reported profits are now six times more volatile than National Income profits. The accounting practice of marking to market (listing the current value of assets recorded on balance sheets) makes it easier for companies to manage earnings—and can lead to inflation of bonuses.

8.6. The effect of the profits commission at Lloyd’s was to lead to periods of profitability (on which agents received bonuses) and then sudden losses and write-offs which were borne by the Names alone. The same has been happening in banking. Bonuses have been paid on profits but the losses have been borne by shareholders—or, in extremis, the public purse. The lesson is clear: give executives the incentive and the means to overstate profits and they will. Lessons must be learnt here by accountants as well as remuneration committees but the latter can act much faster. Bonuses should not be paid in cash but should be in stock and future cash, the future calculation being done over at least a five year period and adjusted for the subsequent development of the profitability of the business.

8.7. Remuneration mistakes, particularly at the upper end of the pay scale, represent a failure in corporate governance. The Walker Review and the Treasury Committee inquiry on executive pay gave considerable attention to the role of banks’ remuneration committees. The latter was particularly concerned that in some cases remuneration committees appeared to operate like “cosy cartels” offering huge pay packages to their board colleagues but without imposing targets in return. Again ECCR has sympathy with the view of The Treasury Committee that broadening the range of experience found on remuneration committees to include, for example, workers’ representatives would help combat this problem. Involvement of others based in the “real” world might also help.

8.8. Most banks say that generous pay packages are necessary to attract and retain talented employees and that in a global economy and with bankers’ skills in high demand, not paying the “going rate” would mean losing key staff to competitors. Like many other major companies, banks—including those now in, or partially in, public ownership—aim to offer pay packages comparable with others in their sector. This has resulted in a “ratchet effect”, continually moving compensation upwards, leading to suggestions that a global cap is necessary to prevent pay levels spiralling out of control.

8.9. It is a fallacy to suggest that high remuneration is an absolute requirement to attract, retain and motivate staff. The market for executive talent is not the perfectly competitive one that remuneration committees often imply. Excessive pay packages may attract staff who are concerned about their own personal rewards above shareholder or broader interests.

8.10 Any business graduate who has studied Maslow’s hierarchy of needs (first put forward in 1943) would advise that senior executives may be motivated to work hard and serve their company well for a whole variety of reasons including self-respect, job satisfaction, intellectual stimulus, innate creativity, leadership drive, joy in teamwork, a congenial working environment, meeting a formidable challenge, and a spur to excellence. Banks need to recognise that money is not the sole, or even the main, motivator at senior levels

8.11. Regardless of whether remuneration structures may have helped cause the crisis, there is a widespread view that senior bankers are simply paid too much. Top bankers’ pay exaggerates the social value of the job. Excessive pay in any industry contributes to increasing economic inequalities, which are bad for society as a whole. There is compelling evidence that in less equal societies, quality of life, measured by a range of health and social indicators, is worse for virtually everybody. It is hard to refute the argument that bankers’ pay has contributed to rising inequality in countries like the UK and USA.

8.12. ECCR, reflecting its Christian roots, has particular concerns about differentials in pay between people at the top of a company compared to those at the bottom, saying that this is more important than the levels of pay outright. The Church Investors Group analysis of pay differentials across FTSE 100 companies leads them to suggest that a good rule-of-thumb would be for top executives’ total remuneration packages to be no more, and preferably less, than 75 times the average pay of the lowest-paid 10% of employees in any firm10. The One Society campaign, run in association with the Equality Trust, advocates an even lower figure for top-to-bottom pay differentials and argues that a ratio of 10:1 is achievable for many organisations. Every bank should look at what the ratio was twenty years ago and ask itself how it allowed the gap to grow so much and what effect that has on employee relations and on wider society tensions and perceptions.

8.13. Despite much rhetoric, actions to regulate banking sector pay have been relatively slow in evolving. In 2009 the Financial Services Authority became the world’s first bank supervisory body to develop detailed rules on remuneration, developing a code of practice which aimed to ensure that remuneration policies, structures and processes accurately reflect risk. In December 2010 the European Union’s Committee of European Banking Supervisors developed further rules that form a common basis for pay across Europe and are being incorporated into national regulators’ codes.

8.14. In the UK this has resulted in tightened restrictions on how bonuses are paid—deferring up to 60% for three years and banning companies from providing guaranteed bonuses for more than one year. It will also prevent so-called “buy-backs” whereby existing employers offer staff guaranteed bonuses to deter them from accepting a job offer from a competitor. Banks will have to be more transparent about pay. While they will not be forced to disclose the names of the highest earners, they will have to disclose aggregate information broken down by business area for senior management and employees who have a “material impact on risk”.

8.15. In spite of the British Bankers’ Association saying that the rules go too far, ECCR questions whether the rules go far enough.

9. Conclusions

Banks are linchpins of modern society, enabling economic activity of all descriptions. They should make an overwhelmingly positive contribution to the economy and society. Since the financial crisis the socialisation of risk has introduced a new dimension into the relationship between the banks and society. While the exceptional rewards remain for the most part restricted to a select few, the costs of failure are borne by the public at large, with very little agreement so far about how society should be compensated.

9.1. Many banks acknowledge their wider responsibilities more readily than they did during the boom years, but it is hard to judge how far this now influences their performance. Mixed progress is apparent on issues such as equal opportunities, customer service and financial inclusion. Still greater challenges appear to lie with banks’ indirect impacts. Despite aspirational statements, there is still evidence (eg recent fines for SBC and HSBC in the States) of banks’ being connected with individuals, projects and transactions over which well-justified ethical concerns arise. Beyond a small group of financial institutions that have developed with ethical principles at their core, most banks fail to effectively integrate social and environmental considerations into their business model.

ECCR’s research has shown that:

Most banks’ business model excludes a proportion of individuals and business from accessing financial services, especially in disadvantaged areas.

Banks’ lobbying activities have considerable impact on policy and are not transparent.

While many banks have signed up to voluntary codes and statements about incorporating social and ethical concerns into lending decisions, they still lend to environmentally and socially destructive projects.

Accounts provided by major banks have facilitated tax avoidance and illicit flows of money from developing countries.

Banks have been associated with tax avoidance—understood as non-payment of tax due and non-compliance with the spirit of the law.

Banks continue to have a role in the debt crisis faced by developing countries.

Investment banks’ speculative trading is a likely factor in recent food and fuel crises.

Banks’ and regulators’ unrealistic assumptions and over-reliance on quantitative risk management techniques very likely led to a widespread failure to apply judgement or to prevent harm.

There is a lack of awareness of regional issues and an unwillingness to make advances on the basis of personal knowledge of customers’ needs rather than just collateral or computer scoring of credit-worthiness.

9.2. The primary task now is to rebuild a banking system in which society can trust: one that manages risk, is financially sound, meets the needs of the public, and recognises the high price that present and future generations will pay if we continue to neglect the Earth’s environmental limits and the harmful outcomes of injustice and inequality. Banks cannot divorce themselves from this context.

9.3. ECCR considers banks have a responsibility and an opportunity to respond positively to current concerns. To the extent that they are seen to use their power and influence to address such challenges, banks will earn back society’s trust. Accordingly we make a number of recommendations to banks that we consider, if implemented, would enable this to happen. Some banks are already undertaking some of these steps. We hope that the recommendations will be far more fully and widely implemented.

9.4. We fully accept that banks have to respond to regulatory and other external pressures. In that context we endorse the recent Kay report suggesting that quarterly reporting can be harmful and encouraging companies and investors to adopt longer time horizons. Sustainable companies have to have regard to their performance and reputations over decades not months.

10. Recommendations for Regulators

We make the following recommendations directed primarily at financial service regulators.

10.1. Responsibilities of non-Executive Directors

Parliament should consider giving statutory force to some of the wider responsibilities of non-executive directors requiring them to consider the long-term and wider social issues in the company’s decision making.

10.2. Whistleblowing Incentives

UK regulators should consider ways to encourage whistleblowers within banks and other companies to come forward. This could include a revival of laws that would allow private citizens to share part of any fines received by the authorities as a result of their whistle-blowing.

10.3. Remuneration

Parliament should consider whether current regulations on remuneration and transparency of remuneration are sufficient to curb excesses and ensure that there is “no reward for failure”.

11. Recommendations for Banks

The following recommendations are primarily directed at banks. However we there is a need for Parliament to consider the extent to which it can usefully put mechanisms in place to encourage their adoption.

11.1. Codes of Conduct

Every bank should have its own code of conduct. This should state the core principles that guide the bank. It should make it clear that every employee is expected to comply with the code and that non-compliance is a reason to terminate employment. The code should also state explicitly that employees identifying non-compliance should report that non-compliance to an identified Compliance Officer and if the report is upheld will be appropriately rewarded. All employees should receive appropriate training about the Code and in the case of management and lending positions this should include consideration of a series of case studies aimed at helping employees identify the moral issues and the reputational risks for the bank; it is not fair to assume that every employee will recognise the difference between right and wrong in every situation.

ECCR suggests such codes should not only comply with regulatory minima and suggestions in the Global Reporting Initiative, The Global Alliance for Banking Values, and UN Guidelines but should contain explicit statements on at least fourteen social, ethical and environmental concerns material to most of the major UK banks11.

11.2. On customer Service, Banks should:

Work to achieve consistently positive customer feedback.

Reduce the proportion of customer complaints upheld by the banking ombudsman.

Strengthen the way they monitor and rectify complaints.

Be more transparent about the different interest rates they offer and charge to customers.

Make greater efforts to “know their customers” and use that knowledge in lending rather than rely on centralised, computerised credit-scoring

11.3. On Financial Exclusion, Banks should:

Publish information, and ensure staff follow government guidelines, on alternative identification allowed for new customers opening accounts.

Publicly report the number and percentage of active basic bank accounts they hold and about lending to small businesses in deprived areas.

Be more transparent about penalty charges for unpaid direct debits and cheques.

Train frontline staff in the promotion and use of basic bank accounts.

Commit not to withdraw counter services when they are the last financial institution in a community without an independent social impact assessment showing no adverse effect.

Consider changes to account facilities in consultation with financially excluded customers.

Consider supporting, and when appropriate referring customers to, community financial institutions.

11.4. On Responsible Credit, Banks should:

Publicly report the volume of credit they make available to individuals and businesses and break this down by demographic group and geographical area.

Provide clearly written, not misleading, information on loans and other credit products.

Have clear policies and procedures for fair and respectful treatment of individuals experiencing difficulty servicing loans and use home repossessions only as a last resort.

Publicly report complaints or prosecutions upheld against them for unfair lending.

Ensure that remuneration structures for frontline staff incentivise responsible lending.

11.5. On Gender Equity in Employment, Banks should:

Develop an action plan and work towards gender parity at all levels of employment.

Publicly report on the gender balance of employees and at board level.

Carry out regular equal pay audits and report top-level findings and recommendations.

11.6. On Lobbying, Banks should:

Fully complete the European Commission lobbying register.

Publicly report on all other lobbying and on their representation on high level committees or expert groups likely to influence government policies.

11.7. On Lending, Financing and Asset Management, Banks should:

Preclude provision of services to socially and environmentally harmful proposals.

Ensure that asset managers take full account of social and environmental considerations.

Publish all social, ethical and environmental policies they apply to lending, financing, asset management and provision of other services.

Increase the proportion of renewable energy, energy conservation and other environmental protection projects in their portfolios.

Include social and environmental analysis as a standard component of mergers and acquisitions advice and brokerage reports.

Be transparent about their lending by providing information, on a regional and national basis, about the companies and projects they fund and any social or environmental grounds on which they decline loans.

11.8. On Money Laundering, Banks should:

Confirm the identity of all customers before accepting funds and have systems to identify Politically Exposed Persons (PEPs) and beneficial owners of companies.

Refuse to open accounts for PEPs where precluded by the law of a PEP’s country.

Conduct enhanced due diligence on PEPs and sectors, companies and countries most associated with corruption.

Refuse to handle funds where that is part of an attempt to avoid sanctions or taxation, or the processing of funds derived from illegal operations

Publicly report any prosecutions or fines for the contravention of anti-money-laundering regulations.

Ensure their compliance department has an independent reporting line to the board.

Create mechanisms to reward compliance officers even when their work leads to business being turned down.

11.9. On Tax Avoidance, Banks should:

Report on a country-by-country basis on all taxes they pay on their own profits.

Ensure that customers are aware of their own tax obligations.

Refuse to provide tax planning that does not serve genuine business transactions.

Not be party to plans to avoid taxation on profits earned within a country, nor to aggressively move profits earned over international activities into tax havens.

11.10. On Developing Country Debt, Banks should:

Publicly report on their exposure to developing country government debt.

Carry out enhanced due diligence before committing to loans to developing country governments to avoid undermining poverty reduction efforts.

Carry out enhanced due diligence before committing to projects or arrangements benefiting from export credit agency support.

Apply social and environmental criteria to lending benefiting from export credit agency support.

Publish non-confidential information about export credit agency arrangements.

11.11. On Commodity Speculation, Banks Should:

Examine the social and environmental consequences of speculative trading

Put limits on speculation where there is a risk of significant environmental or social harm.

Ensure that derivatives are traded transparently on regulated exchanges.

Be transparent about any lobbying activities seeking to influence regulation

11.12. On Risk Management, Banks Should:

Encourage senior level discussion of risk.

Continually evaluate exposure to risk within the financial system and the extent to which the bank contributes to such risk.

Apply the precautionary principle to minimise their contribution to systemic risk.

Ensure a responsible attitude to risk throughout the business.

Have an independent risk committee and publish an annual report of its activities.

Ensure a balance between financial expertise and other experience among board members, particularly non-executives. Ensure that non-executive directors limit other roles such as trusteeships or directorships so as to be able to play an effective role on the Board.

11.13. On Remuneration, Banks Should:

Take into account the views of external stakeholders when establishing remuneration policies and structures.

Ensure that remuneration structures: do not encourage excessive risk taking; are commensurate with long term performance and shareholder value; include consideration of social, ethical and environmental factors; do not undermine the need to lend responsibly; include indicators of customer service and fair resolution of complaints.

Publish the absolute value of, and ratio between, the remuneration of their highest paid employees and the average salary of the lowest paid 10% of employees and seek to continually reduce this ratio.

11.14. On Human Trafficking, Banks Should:

Establish mechanisms to ensure that they do not employ, directly or through sub-contractors, trafficked people.

Refuse to handle the proceeds of human trafficking or to provide banking facilities to individuals involved in trafficking.

Report to the appropriate authorities any suspicions that clients, suppliers or others with whom they do business are involved in human trafficking.

11.15. On Transparency, Banks Should:

Produce a separate, externally verified corporate responsibility report that at a minimum follows Global Reporting Initiative guidelines.

Publish all policies on social, ethical and environmental issues.

Be transparent about how they are likely to use depositors’ money.

Provide stakeholders with meaningful information on the range of issues covered in reports including the indirect impact of lending activities.

11.16. More information about many of these recommendations can be found in The Banks and Society: Rebuilding Trust. Alternatively an ECCR representative would be very happy to provide more information in person.

19 October 2012

1 For more information about ECCR see www.eccr.org.uk

2 A summary of the recommendations made in The Banks and Society: Rebuilding Trust are included in section 10. The full report can be downloaded at http://www.eccr.org.uk/module-htmlpages-display-pid-86.html

3 Like all business enterprises, banks have a duty under the United Nations “Protect, Respect and Remedy” framework to respect human rights: www.business-humanrights.org/SpecialRepPortal/Home

4 GABV members include Alternative Bank (Switzerland), Banca Popolare (Italy), Banco de la Microempresa (Peru), BancoSol (Bolivia), BRAC Bank (Bangladesh), Cultura Bank (Norway), GLS Bank (Germany), Merkur Cooperative Bank (Denmark), Mibanco, New Resource Bank (USA), OneCalifornia Bank (USA), ShoreBank (USA), Triodos (Netherlands), Vancity (Canada) and Xac Bank (Mongolia). For more information see http://www.gabv.org/

5 The GRI encourages more consistent, high quality corporate responsibility reporting by companies. Guidelines for the financial services sector recommend that companies provide information about issues such as financial inclusion, procedures for assessing social and environmental risks and for monitoring clients’ compliance with social and environmental requirements. For more information see https://www.globalreporting.org/reporting/sector-guidance/financial-services/Pages/default.aspx

6 The Equator principles are a financial industry benchmark for assessing and managing social and environmental risk for project financing. They have been subscribed to by over 60 financial institutions worldwide including Barclays, HSBC, Lloyds Banking Group, Royal Bank of Scotland and Standard Chartered. For more information see http://www.equator-principles.com/

7 The UNPRI is a framework used by the investment industry to incorporate environmental, social and corporate governance (ESG) issues into their decision making and asset ownership practices. They are designed to apply to all assent management activities carried out by a signatory not just finds designated as being “ethical” or “socially responsible”. Being a UNPRI signatory is a useful barometer of an asset managers intentions, but it is not, in itself a clear indication of the extent to which an institution is guided by social or ethical considerations or that it necessarily invests in line with its customers’ values. For more information see http://www.unpri.org/

8 For more information see http://www.handelsbanken.co.uk/

9 See http://performanceandreward.blogspot.co.uk/

10 The Ethics of Remuneration: A Guide for Church Investors, Church Investors Group, March 2011. Available at http://www.churchinvestorsgroup.org.uk/documents/ethics-executive-remuneration-guide-christian-investors

11 ECCR suggests that the areas identified by Bank Track are a good starting place. These include Agriculture, fisheries, forestry, armaments/the military, mining, oil & gas, power generation, biodiversity, corruption, human rights, indigenous peoples, labour rights, operations in conflict zones, taxation and toxic materials. For more information see http://www.banktrack.org/

Prepared 19th June 2013