The capstone of regulatory reform in the wake of the financial crisis can be characterized as an effort to change the financial industry by getting bankers to behave more ethically. Regulators have emphasized the importance of “culture” set by a “tone at the top” that makes “ethical conduct” a primary organizational value—though they have not given much content to any of these terms.
Janet Yellen, chair of the Federal Reserve Board, has said: “[W]e expect the firms we oversee to follow the law and to operate in an ethical manner. Too often in recent years, bankers at large institutions have not done so, sometimes brazenly.” The New York Fed has made a priority of ensuring that the banks it supervises are managed ethically.
In Ethical Bankers, we investigate what this turn to regulation by ethics might mean. Standards-based, rather than rules-based, ethics in banking is a term rarely defined with precision. To make matters even more indefinite, calls for ethical bankers are frequently couched in the language of cultural change.
Ethical banking represent a next step in a broad-reaching effort to recreate credible financial standards after the financial crisis, and one fascinatingly different from prior efforts. Post-crisis reform has been many things, but one unifying principle has been the development of highly detailed and usually quantifiable measures of the positions and resources of financial institutions. There is nothing quantitative or detailed about the push to impose ethics on banks.
Ethical banking regulation can instead be understood as a way to bring to banking a set of commitments that would mimic the core values adopted by professional responsibility codes. Doctors, lawyers, and accountants all police their professions with codes of ethics. They do so by limiting the ability of professionals to act in their pure self-interest at all times. Instead, professionals must in some circumstances put their clients’ interests ahead of their own, and must in others serve as a government agent — as in the case of lawyers acting as officers of the court, doctors acting as servants of the public health, and accountants acting as the guarantors of truthful disclosure and the gatekeepers of compliance with the securities laws.
Banking is not like those professions, however. A public service requirement might make sense in exchange for professional monopoly rights granted by state accreditation, which lawyers and accountants enjoy. But there is no banking monopoly; the modern banking industry has never been more fragmented. Shadow banks that are not regulated like banks, but provide financing like banks, have taken market share from conventional institutions. These shadow banks include money market funds that finance the day-to-day operations of large firms with their appetite for commercial paper, venture capital funds that finance and develop new businesses, business development corporations that invest in small and midsize firms, and hedge funds that can take on any of these functions, along with others. These institutions increasingly do what banks do, but no one expects hedge funds or money market operations to take on the mantle of public service.
Banks do not only provide services and advice to their clients. They also sell them a product: money, in various bundles, at a price. As salesmen as well as advisors, bankers make uneasy candidates for the “put the customer first” rules of the professions. It is pointless to insist on a uniform ethic of client service when bankers sometimes occupy roles as trusted advisors, but at other times act as middlemen who operate between buyers and sellers of products—especially when bankers, like anyone else, are governed by the strictures against fraud and in favor of good faith
The best case for banker ethics is not that bankers are like lawyers, but rather that bankers, perhaps uniquely, must buy into the system of regulation if it is to succeed. Banking regulation has long been high-touch, low-opacity regulation. The regulators sit next to the bankers and communicate as much through discussions about, say, position limits and new lines of business, as through specific rules setting forth appropriate conduct or its opposite. In this sense, banking regulation is nothing like, say, an Environmental Protection Agency rule on the sort of emissions levels that will be tolerated. There are fewer such rules, and more discretion, applied through the sort of daily oversight that other regulators cannot offer. Hundreds of Federal Reserve Board staffers work inside large banks every day; other regulators do not embed in their charges. Moreover, all of this—the regulatory relationship, the nature of the instructions issued by regulators to their charges, and the nature of the response—is shrouded in secrecy. This sort of regulation may require a degree of willing cooperation from the banks to work at all.
In our view, informal regulation can work, particularly in the context of the coordination of international oversight over a global industry like the financial services industry. But we are skeptical of these calls for a warm—and seemingly quite fuzzy—culture of ethics. We urge caution in delineating the use of “culture” and “ethics” in the context of banking. Critical engagement with the concept of culture can yield specific insights about how ethical behavior might come to be self-sustaining within the banking profession. But cultural improvement can only be part of the way that the government regulates banks. Cultural change is difficult and, in our view, should be undertaken only if one is clear-eyed about the limits of the work a culture of ethical banking could do.
This post comes to us from Gwendolyn Gordon and David Zaring, professors at the University of Pennsylvania. It is based on their recent article, “Ethical Bankers,” available here.