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Ethical Issues Facing the Banking Industry

Ethical Issues facing the Banking Industry.

Financial institutions -including banks of all sorts, credit agencies, private equity firms, pension funds, insurance companies, and the like- have long been considered by most people to have no other object in view than the creation of wealth. The performance of financial institutions is therefore measured solely on the basis of their capacity to maximize financial assets, that is, it has been measured with evaluation factors that review only their monetary bottom-line results. How much return do they get on their investment decisions? How much are they able to maximize the assets in their custody? How much profit can they derive from the loans and credits they subscribe, from the bonds they float, from the equity they successfully issue on the financial markets? Banks are judged by their ability to develop financial instruments such as complex derivatives and sophisticated credit schemes that help connect the money of investors with the companies in need of those financial resources in the best possible way. In pursuing these ends, banks, and financial institutions in general, have long defended the confidentiality of the information pertinent to their business, be it data about their clients, the sources and the destinations of the economic resources they handle, their credit-giving policies and procedures, and many more aspects of the banking profession that tend to be little transparent and not very communicative about their way of doing business.

Financial institutions have become very complex and sophisticated in the way they operate. The products and services they offer tend to be more and more complicated. The ways they invest resources, the way they design, promote, and implement credit facilities, all become less evident year after year, and the speed at which they evolve is ever accelerating. This complexity and sophistication of the industry is in part a response to the shifting and ever-growing needs of the banks’ clients. Companies in need of financing, and of financial services, tend to have more and more complex businesses with complex needs and requirements of capital. Globalization also plays an important role. Banks’ customers often do not have a localized headquarters but they operate virtually everywhere in the world. Today, it could be argued, it is more difficult for banks to know in detail where these customers operate and what exactly they do and how they run their businesses. Moreover, clients change, merge, get acquired, move in and out of businesses and markets much more rapidly than in the past. It is not only banks that change so quickly, but their clients, and their clients’ needs also move and evolve at a higher speed.

Unfortunately, governments, regulators, and other institutions simply cannot cope with this rate of evolution in a satisfactory manner. Banks are moving too quickly for the reaction-time of governments and other organizations. As a consequence, many important issues are being overlooked by the institutions charged with directing our societies toward the common good.

Were one to give only a superficial consideration to the financial institutions and the implications of their actions in the world, one could erroneously conclude that money is just another commodity being traded. There is a danger that money will be treated as just another product that makes things possible, as a simple means to accomplish an end. However, such an approach bears the risk of becoming a highly inhumane approach when we look it in detail.  Money is not just another commodity being handled. Money, both in the form of credit and in the form of investments, makes a huge impact on the world. Money is a means, not an end; but, it is a powerful means to do things and therefore evil use of money can indeed create a considerably negative impact on our world.

Where money comes from, and the destination it might have (that is, the sources from which it proceeds and the places where it ends up being used), should not be treated as “just another business transaction”. Money, in all of its forms, has implications and consequences. The things we do with money, and the things we allow to be done with money, are not irrelevant from a moral and an ethical perspective. Money implies actions, money allows things to happen, money promotes and enacts changes. Money is a very important, if not the most important fuel for the happenings in the world. Money helps, money builds, money buys, money creates and acquires, but money can also destroy, pollute, kill, and support evil. Money should not be considered simply in terms of the percentage points being generated as a return on an investment over a period of time. Given that banks are the official intermediaries of money, we need to look at how they handle money and what they do with it. By facilitating money to others, financial institutions enact and empower them to do things with it. What clients end up doing with the money they get from a bank, then, is then not irrelevant from an ethical viewpoint. This is all the more obvious when we consider that the money banks handle, is indeed to a large extent, investors’ money, not their own.

To handle money as a commodity with no ethical implications and impact is to overlook critical moral issues, issues that could in fact be financed, and thus, enacted, promoted, and effectively created, by the investors’ money. In the end, whose money is the banks’ money? Who in fact owns the money that financial institutions are investing and lending? In the end, it is the money of individual investors. It is the money of pension funds, constituted in turn by the savings, the taxes, the retirement plans of single individuals like you reading this paper.  

Given the fact that money can be used in a wrong way -and it frequently does get used in such a way- and considering that money is eventually funded to a very large extent by individual investors, we should ask: is it still morally acceptable that financial institutions invest and lend money indiscriminately, watching only the bottom-line? Should bank secrecy and confidentiality never be held to answer for the moral and ethical implications that money can have in our world? Is it acceptable that governments and regulators lag behind financial institutions’ questionable way of doing businesses because “the markets can’t wait”? Can we rightly ignore where our money is being used, what it is financing, where it is being invested, as long as it generates a good return in percentage terms? Can banks really justify their arms-length approach to their investments and financing consequences and impacts on our world as far as they generate more money?

How banks use money is not irrelevant from a moral and ethical perspective. Crime, pollution, corruption, violation of human rights, threats to human life, totalitarian regimes, and all sorts of wrong-doing need and use money every year. Financial institutions play a key role in the supply and movement of money. In this essay we intend to draw your attention to the key role the banking industry plays in that supply chain of money. Moreover, we will call your attention to the fact that it is your money, which can play a key role in that supply chain and that is not morally or ethically avoidable anymore to investigate and to actively question how banks are using that supply chain to channel your money, with financial practices that can be fueling wrong doing across the world. Let us clarify that, whenever investors’ money is channeled to evil-investments by financial institutions, it is the bank who is guilty of this wrong-doing and not the individual investor, unless of course, the individual investor were aware of the wrong-doing (and if he were just as easily able to invest his money elsewhere, and if he were a significant enough investor to influence the company or fund in question). What we attempt here is to call the investors’ attention to the importance of the potential damage that their money could do when invested in the wrong destinations.


What are our main concerns?

We have several concerns regarding financial institutions and how they use money. Banks can channel economic resources in different ways that make money result in some form of evil-doing. The two main ways in which banks can do this are (a) by lending money to others, that is, by issuing credit facilities to their clients, these being customers corporations, governments, individuals, etc., and (b) by actively and directly investing money, that is, owning shares,  be it in the name of others or for themselves, in companies, projects, or countries, that conduct different forms of wrong-doing. Owning shares of companies that could be conducting wrong-doing is, of course, not exclusive to financial institutions; however, the large sums of funds that banks have available to invest make these investments particularly relevant when we analyze ethical issues facing banks.

When banks lend money to others, the bank may not be doing wrong by itself; it is these other entities which might be engaged in wrong-doing. However, this does not excuse banks from their moral responsibility. Money enables and promotes actions, and in this sense, banks lending money to evil-doers are facilitating their activities. It is not valid to argue that a bank is only in the business of financing and lending and that therefore they carry no ethical responsibility in the wrong-doing. Banks effectively enact, enable, and promote the realization of actions with their lending of financial resources. In the lines below we will discuss how banks and financial institutions have been known to effectively fuel wrong-doing through the issuance of credit facilities to clients in questionable businesses, and through other actions that range from actively holding shares of companies with questionable practices, to speculation and other questionable matters.

1.- Usurious practices.

Banking is a business concerned with protecting and growing people’s money. As such, one of its principal purposes is to generate wealth, in the form of financial returns for its shareholders. As in any industry, it is understandable and acceptable that banks try their best to maximize their investments and therefore, it is logical that banks charge interest rates on the loans and financing activities they offer to their clients. However, banks that charge excessive interest rates, abusive commissions, or ultra-profitable credit charges that go beyond reasonable standards for taking an extra benefit from a specific situation in detriment to their customers, are guilty of usury.  Usury may be defined as demanding significantly more money back from customers than is just and fair. Financial institutions consistently engaged in usury are accordingly a subject of our concern. While we do not necessarily endorse bureaucratic regulations which may be excessively burdensome and counter-productive, we do expect banks to act morally with respect to lending practices within their organizations which are potentially usurious. We are concerned that banks are frequently charging excessive rates and imposing unfair advantages for themselves upon customers. We thus expect banks to take care to implement policies that prevent wrong-doing in the form of usury and similar sorts of abusive practices.

Financial institutions are also guilty of some forms of usury when they encourage their customers, especially individuals, to go into excessive debt by taking irresponsible credit at too high interest rates. Some credit customers, specially those located in low-credit penetration communities are frequently being subjected to excessive marketing and pressure to drive them into credit at advantageous interest rates that go beyond what is customary in the industry.

2.- Speculative banking.

The assets a bank lends and invest should be handled responsibly, even moreover so, when we consider that the bank is investing and lending money that belongs to other people, i.e., the individual and institutional investors whose money they manage. Engaging in excessively speculative investments and irresponsible credit lending practices is morally unacceptable, and in many cases, not even good business. We believe bankers and financial professionals should take a responsible approach in all investment and lending operations with its customers’ money. Even in the case of high-risk, high-return type of clients, a bank is the ultimate entity making the investment decisions for the investors, and practices of speculatively investing heavily in too-risky securities just for the sake of short-term returns should be considered cautiously, especially given the massive loss of wealth that we have witnessed during the current financial crisis. The point is that there is always an ethical component involved in these too-risky investments that is being ignored. This crisis has made evident that investing in financial securities of questionable value (such as derivatives without the adequate collateral, sub-prime mortgages, irresponsible adjustable-rate-mortgages, and other investments that do not undergo the serious due-diligence required) have frequently resulted in clients’ wealth destruction.

The situation of over-speculative, over-risky banking gets especially complicated from a moral perspective when we consider that clients seldom receive the necessary, detailed information to let them know what kind of investments their bankers are undertaking with their money. Another aspect of concern regarding speculative banking, which has also been evidenced in this crisis, is the fact that many financial institutions have been involved in speculative investments resulting in enormous losses for their customers while their executives continue to receive compensation packages and bonuses in the millions of dollars. While we understand that the banking profession has traditionally generated a lot of wealth for its executives, their excessive bonuses become an ethical concern when their clients’ wealth has been destroyed precisely because of these forms of speculative investment practices.

3.- Financing arms manufacturing and trade.

Many banks are actively financing the military industry around the world. While we recognize the moral acceptability of a country taking care to defend its population, and thus investing in arms and weapons, we are concerned with excesses and human rights violations involved in this activity. We are specifically referring to indiscriminately destructive, overly-damaging weapons and their manufacturers and distributors. These usually fall in the category of so-called “cluster munitions” which are highly-destructive weapons which not only destroy an enemy’s military target, but quite frequently kill thousands of innocent civilian victims.

Why are cluster munitions so harmful? Cluster-munitions are designed to destroy large areas, thus their use often results in the destruction of civilian settlements, killing innocent people. On top of this, cluster-munitions weapons cause damage after the military attack as they contain many explosive components that did not act at the moment of the attack but remain active there, and explode afterwards. A potential mine field is created wherever cluster-munitions have been used and their destructive potential can last for years hidden under the ground. This information has been corroborated several times by different organizations around the world, and yet regulation does not actively prevent the manufacturing of these weapons, and of course, regulation doesn’t prevent financial institutions from either investing or lending money to these companies.

It is believed that a large percentage of cluster-munitions victims are civilians. Several studies support these statistics, and yet, manufacturing companies have no difficulties in securing credit from banks. More than 60 financial institutions have been identified to be involved in financing these companies, and it has become such a lucrative business that between the period of 2004-2007 more than € 10 billion euro have been channeled to the six major cluster-munitions manufacturers which are: GenCopr (USA), Lockheed Martin (USA), Raytheon (USA), Textron (USA), Thales (France), and EADS (The Netherlands). All these companies openly produce cluster-munitions arms that have been used in several conflicts such as in Iraq (by the US army), in Lebanon (by the Israeli army), and many other places like the former Yugoslavia or Sudan.

Some weapon-manufacturing companies have obtained credit facilities of very considerable sizes from well-kwon financial institutions. We are talking about credits in the billions of dollars. We cannot pretend that Banks did not know the purpose of the financing facilities they were arranging.

Even worse is the fact that banks now also own shares in these cluster-munitions manufacturers. Several reputed financial institutions own shares in companies like GenCorp, Lockheed Martin, Textron, and Raytheon, which add up to double-digit equity positions in those companies. Owning shares in a company known to manufacture such weapons has ethical and moral implications. Money invested in securities enables companies to do things with it, and therefore, these investments have corresponding ethical repercussions. To own such a considerable amount of equity in a company means the owner is actually involved and interested in the progress of that company and in the performance of the products it manufactures and sells.

4.- Financing and supporting totalitarian regimes.

Banks frequently give loans to companies operating in countries governed by totalitarian regimes such as Burma, North Korea, or Sudan. Those companies in turn use the money to enter those markets. Some of these countries are plagued with corrupt government authorities that frequently require them to give substantial bribes to allow them to operate in those nations. By financing these companies, banks are allowing money to flow into these totalitarian regimes which have no respect for human rights and who use this money to strengthen their positions in their respective countries.  The fundamental problem is not that a company be present in a country with a repressive regime, but that its business there is somehow complicit in propping up or perpetuating the repressive regime.

5.- Financing of companies with little or no commitment to social responsibility.

The banking industry usually grants credit facilities to companies, and helps in raising capital in the financial markets, to companies operating with no socially-responsible agendas, or with little commitment to one. We are referring, amongst others, to companies operating in third-world countries that allow child-labor, overwhelming pollution of the environment, black economies, and so forth. We have observed companies that have little respect for their workers and which have consistently violated labor laws (mainly in developing countries) having no problem securing credits from well-known banks. So far, banks have not been interested in questioning clients about their human-rights or social-impact agendas. Banks tend to look at the risk-return ratio of their investment as the sole basis for granting the credit.

Some banks are financing companies, for instance in the infrastructure industry, that operate in a highly utilitarian way in some countries. Some infrastructure developers, for example, that build water dams around the world have been accused of impacting the communities in which they operate by forcing the displacement of people from their home communities to build the dams wherever it is more economically convenient for them to build them, regardless of the social impact this might have. Moreover, these companies have been accused of manipulating potable water sources in poor countries by linking itself to corrupt governments like the Burma Junta or the regime in Sudan. Banks lending money to companies like these facilitate their operations, and thus, often their wrong-doing. Making money available to companies operating in this manner fuels their wrong-doing. Funds channeled to these types of companies can easily end up in the hands of those totalitarian regimes. These funds are not only the bank’s money, but more importantly, the individual investor’s money. 

6.- Ecological Impact.

We should expect banks to start looking more in detail at the potential ecological damage that their clients could be generating when receiving financing from them. Companies known to be involved in activities that result in substantial environmental damage through the extraction of fossil fuels for instance; companies polluting the seas through the release of toxic chemicals; companies that manufacture products which persist in the environment and are linked to health concerns; and any other company damaging the world should not receive financing so easily as they do today from banks and financial institutions. While we recognize that avoidance of all possible environmental damage is often very expensive and hard to achieve, we believe that the efforts should be at least seriously pursued. We expect companies to actively search for a balance between their activities, their production processes, their use of natural and human resources and the respect for the environment.  

The same goes for companies involved in unsustainable harvest of natural resources, including fishing, timber, and other natural resources should also be severely questioned by banks when asked for financing. Moreover, banks, pension funds and in general, every investor, should be very cautious when it comes to buying or holding securities (be it bonds, shares, etc.) in all these kinds of companies. By investing in these environmentally unfriendly companies, financial institutions give them access to important sums of capital, which in turn, results in larger environmental damage.

The same rationale goes for companies involved in aggressive, unnecessary animal testing of cosmetics and household products or ingredients. We recognize testing is an important step of many manufacturing processes; it is abusive, unnecessary, excessive, testing which we want to avoid. Intensive farming methods, blood sports, trade in the furs of endangered species, and other animal unfriendly businesses are also of our concern when they make use of animals for unnecessarily violent and superficial entertainment activities.


7.- Financing, donations, and sponsorships contrary to the good of the family.

As financial institutions handle huge amounts of capital, the impact of their donations and sponsorships can be substantial and the money they channel through donations can have important impact on society. In this respect, we are particularly concerned with banks giving active support to organizations that advocate against the institution of family and against family-values. As we are convinced that the family is the basis for any healthy society, we are interested in seeing banks staying away from initiatives that somehow can affect the integrity of family or attack family values in any way. These activities could include granting financial support to causes that actively promote activism against family values. While we acknowledge that there are other points of view regarding the value of families and their role in society, we prefer to keep our investments, and recommendations for our clients’ investments away from companies promoting non-family friendly causes and activism. We prefer not to generate our wealth from investing in companies that opt for financing, promoting, and supporting entities and organizations that do not share our view on family and family values as the cornerstones of society, peace and harmony.

8.- Involvement in social enterprise.

The banking industry plays a key role in the development of the markets in which it operates. By lending and raising money, a bank can effectively help develop a community, but further than that, a bank is expected to get actively involved in supporting the development of that community in which it operates. More and more banks and financial institutions are praised when they support organizations such as cooperatives or credit unions, or get involved in financing of community initiatives.  Given the fact that a bank benefits directly from the economic resources of a community, we would be concerned when a bank openly neglects to help those communities in which it conducts business.


Is a better banking industry possible?

The answer is absolutely YES. Better, ethically-responsible, respectful banking and financing industries are not only possible, but also highly desirable, and they are already starting to emerge. Some banks, mainly small institutions in developed countries have realized the importance of being ethical beyond their internal Code of Values, that is, beyond paper and beyond what is strictly within its operations. Individual investors will play a key role in putting pressure on banks and regulators to let them know that banking practices cannot go on as independent of ethics any longer. The relevance of what banks do with the people’s resources is material.

A number of organizations around the world are starting to pay attention to how money is being used and to the moral implications it has. Some important institutional investors are becoming much more concerned with the handling of their investments. Institutions like the Government Pension Fund of Norway, the so called, “Folketryfondet”, the world’s largest single holder of equity securities, has been implementing strict ethical criteria to handle their investments. Some bank-industry watch-dogs like Bank Secrets Organization or Netwerk Vlaanderen of Belgium, have started to lobby regulators to implement stronger policies for the banking industry.

Eiris Research of Ireland has been advising individual and institutional investors to make them conscious of the moral relevance of taking care where their money is been invested. Some banks like Triodos Bank of the UK are starting to offer their clients alternative ways to invest their money considering the ethical and the financial impact of their investments. Some government agencies like the UK Treasury have started to work on designing better regulation for the banking industry. The world is changing and investors both individual and institutional are starting to pay attention to the ethical implications of their money. A world where investments and loans are made on the pure basis of financial return is not any more acceptable and we at Fidelis International Institute are here to make our contribution.

January, 2010.

Ricardo Sánchez Serrano

Fidelis International Institute


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