The social reform of banking.

• Author: Williams, Cynthia A.

1. INTRODUCTION II. THE ANTHROPOLOGY OF CORPORATE CULTURE III. THE CURRENT STATE OF FINANCIAL INSTITUTION CULTURE A. The Too-Big-to-Fail Problem B. A Culture of Insecurity C. Compensation Structures that Exalt Risk and Self-Interest IV. INSIGHTS FROM ORGANIZATIONAL PSYCHOLOGY A. Developing Organizations that Promote Ethical Behavior B. New Governance and the Development of Productive Culture V. AN EXAMPLE OF NEW GOVERNANCE IN ACTION VI. SUGGESTIONS FOR REFORM A. Public-Private Governance Partnerships B. Internalizing Negative Externalities C. Changes in Accounting and Disclosure and the Effects on Competition 1. An Example of Social Accounting: Integrated Reporting/The International Integrated Reporting Council 2. Potential Implications for Cultural Reform of Financial Institutions VII. OBJECTIONS AND RESPONSES "The idea that there is something called 'the economy', which is separable from the welfare of society and its citizens, is silly." (1)

   "The economic power in the hands of the few persons who control a giant corporation is a tremendous force which can harm or benefit a multitude of individuals, affect whole districts, shift the currents of trade, bring ruin to one community and prosperity to another. The organizations which they control have passed far beyond the realm of private enterprise--they have become more nearly social institutions." (2)

1. INTRODUCTION

   When the global elite gathered to discuss the state of the world economy at the World Economic Forum in Davos in January 2011, the prevailing mood ranged from optimistic to exuberant. The apocalypse had been averted, and it seemed that the financial system and the world economy were both recovering. But there was an ant at the picnic: Barrie Wilkinson, an analyst from the international consulting firm Oliver Wyman, whom a Bloomberg reporter dubbed the "Loneliest Man in Davos." (3) Wilkinson (whose lower-rung credentials kept him out of the most exclusive celebratory events) had written a report for his company that concluded as follows:

   [F]or all the rhetoric around a new financial order, and all the improvements made, many of the old risks remain. The basic regulatory framework--of bank debtor guarantees and regulatory bank capital and liquidity minima (that is, of risk subsidies and compensatory risk taxes)--has been maintained with tweaked parameters. And, within this system, bank shareholders, bondholders and executives still have incentives that might herd them towards excessive risk taking. (4) In its analysis, the Oliver Wyman report emphasized a number of fundamental problems that it argued had not been solved. (5) A particular concern was that shareholders' unwillingness to accept the lower returns on equity that higher capital requirements would produce would lead banks to shift resources either into commodities or emerging markets with expectations of higher returns. This reluctance to accept lower returns would create two problems: it would either fuel new asset bubbles or cause banks to continue to shift banking functions into the less-regulated interstices of the shadow banking system.

   By today, however, that analysis seems understated, especially after a particularly scandal-plagued summer in 2012, with echoes in 2013. Not only is it now clear that the old risks remain, but it is becoming increasingly clear that there are additional, deeper problems to confront. Thus, in rapid succession, public charges emerged that traders at up to sixteen of the too-big-to-fail global banks, including Barclays, Citigroup, UBS, and HSBC, had engaged in global manipulation of the London inter-bank offered rate, or Libor, for at least five years. (6) In addition, charges surfaced that HSBC subsidiaries had been knowingly laundering money for drug cartels, terrorists, and pariah states for over a decade; (7) that the vaunted risk mitigation systems at JPMorgan Chase had been insufficient to prevent $5.8 billion worth of surprise losses in synthetic derivatives hedging; (8) and that between $21 trillion and $30 trillion had been stashed away in tax havens by the global super-rich, which could not have happened without banks' assistance. In 2013, an emerging issue included JPMorgan Chase's and Barclays' alleged manipulation of prices in energy markets, which was part of the regulatory concern with banks' role in the trading and delivery of commodities generally. (9) And at the end of 2013, the U.S. Department of Justice announced yet another investigation, this one involving alleged manipulation of the foreign exchange market by a group of bankers who called themselves "the cartel," within Citigroup, Barclays, Royal Bank of Scotland, UBS, and Deutsche Bank. (10)

   If even some of these charges are true, people in elite, global, too-big-to-fail ("TBTF") banking entities have harbored and assisted global criminal conspiracies and enabled tax evasion on a staggering scale, even as their core functions continue to have the potential to produce unexpected, outsized financial risk. So damaging have these revelations been that the banking public relations machine, led until 2012 by JPMorgan's Jamie Dimon, has been knocked off stride, at least temporarily. (11) Opinions were expressed on both sides of the Atlantic that it is time to reinstate Glass-Steagall's separation of commercial and investment banking; (12) that the Volcker Rule limiting proprietary trading by banks and the Vickers Commission's "ring-fencing" of retail banking are insufficient; (13) that investment banks should once again be required to be private partnerships; (14) that it is time to look more carefully at alternative banking systems, such as co-ops and ethical banks; (15) and that the TBTF banks need to be broken up. (16) Astonishingly enough, Sandy Weill publicly expressed that last opinion in late July 2012, even though Weill was an architect of the Citigroup series of mergers that was the coup-de-grace to Glass-Steagall in 1999, and which ushered in today's era of TBTF universal banks. (17)

   These developments portend further regulatory interventions to reform finance on both sides of the Atlantic. Yet, given market participants' propensity to engage in regulatory arbitrage, one can feel a bit pessimistic about the ability of regulation alone to wring excessive leverage, fragility, and risk out of the banking system. Indeed, as this essay was being written, the New York Times was reporting on a new fund, called the Ovid Regulatory Capital Relief Fund, that is investing in "capital relief trades" or "regulatory capital trades" that allow banks to shift assets off their books by buying credit default swaps being sold by the Fund. (18) Even without regulatory arbitrage, the risk-adjusted capital adequacy requirements at the core of the prevailing international banking standards (Basel II and III) (19) require banks to make good faith determinations of the kinds of risks to which their loans and investment portfolio give rise, and there is widespread concern that these determinations can be manipulated. (20) And even if the banks do act in good faith, the leverage ratio of Basel III, requiring equity of at least 3% of total assets, will not go into effect until January 1, 2019, and this leverage ratio has already been called "outrageously low" by prominent academic critics. (21)

   New regulations may well be necessary, but our argument in this Article is that they are not likely to be sufficient without changes within the culture of TBTF financial institutions. Therefore, rather than evaluating specific regulatory proposals that are now on the table, this Article will focus instead on another piece of the reform puzzle: the culture within the financial institutions themselves, particularly the global entities that are explicitly or implicitly TBTF. We will explore approaches to regulation that might affect that culture. We do so with some trepidation, not only because it is not obvious at the outset how deeply firm cultures can be influenced by outside factors such as regulation, but also because "culture" as the problem within financial firms seems to be something of a reformist fad.

   In the wake of the Libor (London inter-bank overnight rate) scandal, the UK Parliament has established a Parliamentary Commission on Banking Standards, which is investigating professional standards and culture in the UK's banking industry. (22) The year 2013 started with the CEO of UBS, Andrea Orcel, telling that Commission that UBS was overhauling its culture and "was 'serious about putting integrity over profit.'" (23) This admission was prompted by a number of problems at UBS: its role in Libor manipulation (18 employees involved have been fired and an additional 40 others disciplined); its failures in risk oversight leading to losses of $38 billion in credit derivatives in 2008 and $2.3 billion from rogue trader Kweku Adoboli; and its having to pay a $780 million fine to U.S. authorities for its role in assisting tax evasion by some of its wealthy clients. (24) UBS was followed by Barclays, which was centrally implicated in both Libor manipulation and insurance mis-selling in the UK. (25) Bob Diamond lost his job as CEO over those scandals, and the new CEO, Antony Jenkins, quickly acted to set a more ethical tone at the top, writing a "stern e-mail" to all employees in an effort that one editorial writer described as a "strong start to reforming the bank's culture," while recognizing that "as Barclays' recent history shows, the problem with values statements is making them stick." (26) Barclays then engaged the prominent British solicitor, Sir Anthony Salz, to conduct an independent review of its business practices (the "Salz Review"), and published the results. That review, emphasizing that the problems "faced [at] Barclays [were] to some extent industry problems--though Barclays should take no comfort from this," included both a chapter on Barclays' culture and an Appendix on what culture is...