The Enron scandal has put the spotlight back on ethics. Banks can no longer ignore the issue of social responsibility and those which do may not survive.

"The highest reward for a man's toil is not what he gets for it, but what he becomes by it." John Ruskin

At the World Economic Forum in New York earlier this year, journalists were taken aback. Bankers such as Rolf Breuer, chief executive of Deutsche Bank, and David Komansky, chairman and chief executive officer of Merrill Lynch, co-opted much of what protesters outside the Waldorf-Astoria hotel were saying. The arch-capitalists were sounding pretty sharing and caring.

Reconciling the demands of shareholders, regulators, the local community, non-governmental organisations (NGOs) and the press is forcing bankers to adopt a high moral tone that sits oddly with current imbroglios at energy company Enron and Allied Irish Bank (AIB), let alone the public perception of bankers as interested in making money at the expense of all other considerations. Yet ethics, a set of moral principles held by an individual or a group, encompassing individual behaviour, environmental policy, staff policy and corporate social responsibility, have come to the fore recently. Like a submarine that finally surfaces, the impulse has been building in the past few years but was partially hidden from view. It is a combination of the zeitgeist of the 21st century, brought on by the material excesses of the last 20 years, a realisation of mortality resulting from the attack on the World Trade Center on September 11 and current events such as the AIB and Enron scandals.

Shareholder value

But it is also a marketing necessity on the back of increased transparency. The press and NGOs will highlight any deviations from moral behaviour and this will have an effect on the brand and customer retention and acquisition. "Being permanently in the limelight, global players such as Deutsche Bank cannot afford to neglect the general public's interests," Mr Breuer told The Banker. "To put it in a nutshell: shareholder value is the benchmark for the success of any listed company. It is embedded in a quartet: customer orientation; employee motivation; creation of value for the shareholders; and responsibility as a corporate citizen. It is the top management's task to have these four elements well balanced."

Ethical behaviour is presumably part of all elements of the quartet, although it is particularly visible in corporate responsibility outside the company. Banks are being forced to expand their remits. All this entails higher costs, although as Standard Chartered, a London-headquartered emerging markets bank, points out in a reflection on its code of conduct: "The costs of putting something right are always so much higher than those of getting it right in the first place." But is this just a more sophisticated form of public relations? In part, it is.

"Ethics, social responsibility and sustainability have become significantly more important over the past four years and even more so since the market events triggered by the September 11 attacks on New York," says Hugh Davies, a director at Cohn & Wolfe, an international public relations firm. A study undertaken by the group showed that certain brands in financial services were held in twice as high esteem as those which failed to espouse values associated with social responsibility.

However, you have to "walk the talk" say Mr Davies and others. "If a bank is ethical, it will gain the trust of its clients," says Professor Antonio Argando-a from the IESE business school in Barcelona. "If a bank has a socially responsible fund with the aim of getting more business from its clients and does not apply ethics to [the rest of its behaviour], falsifying the situation, people will realise it."

Mistakes made

He is also adamant that "no-one is ethical 24 hours a day. Things go wrong. But, as long as [the company] apologises and rectifies and starts again, it will recover."

He mentions the case of Electricite de France. A couple of years ago, it denied toxic gases were the result of a fire at one of its plants. The company was in the press for the next month as it slowly amended its story. When something similar happened to it later, it immediately admitted what had occurred and announced what it was doing to deal with the crisis. By day two, the press had lost interest.

More recently, UK bank HBOS admitted in February that it erred when an internal chart was discovered suggesting taxi drivers and window cleaners were not welcome as clients at its Halifax branches. A spokesman immediately acknowledged the mistake, and explained that the bank was not up to speed when dealing with heavy users of cash. As soon as more staff had been recruited and coin-handling machinery upgraded, this would no longer be the case. By the end of the week, the uproar had died down.

In a world where products are increasingly commoditised, the perceptions of a company's brand are sometimes the only distinctive factor. But defining exactly what is meant by ethics, especially in a banking context, is incredibly complex. "One of the concerns I have is that the whole area is very muddled and we are trying to clarify it," says Philippa Foster Back, director of the Institute of Business Ethics, a charity funded by its corporate members such as global bank HSBC and pharmaceutical company Glaxo.

Ethics for financial institutions are an amalgam of corporate governance, environmental policies, labour relations and a host of related topics. But how can this be measured? Ms Foster Back is not sure it is possible. "The trust-me world no longer exists. It is a show-me world. It is about codifying values for stakeholders and shareholders. That is where measurements come in. It is easy to measure environmental [aspects], but measuring ethics is very difficult, it can only be done by anecdote, which is subjective," she adds.

People power

Despite the difficulties, a number of firms are doing so at the behest of investors such as Dutch bank ABN Amro and Calpers, the giant US pension fund. Other investors are more sceptical about how quickly it is becoming a mainstream issue, rather than one for segmented funds with an ethical label.

Mark Breedon, a director at Alliance Capital, which has $280bn under management, recognises that "socially responsible investment is becoming a bigger issue in the market", but says it is a massive process where outside parties will have to provide the screening.

But when funds of the size of Calpers act, it is a clear indication that the trend is gaining momentum. In February, the Californian fund pulled out of four Asian emerging markets (Indonesia, Malaysia, the Philippines and Thailand) on ethical grounds, including labour standards, market regulation, investor protection and accounting transparency. It used Wilshire Associates, a pension consultant, to advise it.

There are also a number of regulatory and legal reasons for the transformation. For example, pension funds in a number of countries have to specify whether the companies they are investing in are ethically responsible. In the US, if a commercial bank lends money to a project that harms the environment, it can be held partly responsible for damages - this applies to foreign banks operating there.

Deutsche Bank's Mr Breuer said that in early 2001, the bank "received an offer to finance a pipeline through a stretch of a South American rainforest. The path of the pipeline was designed to run through 11 protected areas, and the population that lived there, who primarily earned their income from eco-tourism, would certainly be affected by this development."

The bank used external expertise to review the project - something it automatically does for this type of project finance. "After completing the necessary tests, Deutsche Bank felt no obligation to take part in the project," said Mr Breuer.

However, Alan Banks, a former investment banker at UBS and now chief executive of Global Risk Management Services, a London-headquartered firm that provides SRI (socially responsible investments) research, is sceptical that many banks turn down projects on ethical grounds.

"There is a huge discrepancy between what banks say they do and what they actually do in the cut-and-thrust of getting a participation in project finance," he says.

But it is not just an issue of how banks avoid NGO and public relations flak. There is also an upside in how a more ethical bank can see its share price benefit, which Mr Banks believes banks are beginning to realise: "There has been a sea-change as asset managers are beginning to realise how non-financial information is influencing a share price."

US-headquartered Innovest Strategic Advisors is a firm intent on proving the link between market capitalisation and ethics. "Unlike other folks in this [field], we are looking at risk reduction and outperformance. We are looking at how intangibles - such as labour relations, sustainable governance, ability to partner with NGOs and the local community - are a proxy for how well a company is managed," says Matthew Kiernan, founder and executive managing director.

Innovest looked at the share price of 36 international banks over a two-year period to July 2001, according to its ethical criteria. The top half outperformed the bottom half by 7.3%. Admittedly, two years is not a long enough period to prove the point, but it is early days yet in the field.

Rating governance

The two main rating agencies are divided on it. Moody's dismisses it, saying corporate governance is already taken into account in its ratings. Standard & Poor's, though, is taking the opposite attitude. In a four-year project, it has been developing corporate governance ratings and is exploring expanding them to encompass social responsibility.

The S&P project was inspired in 1998 by Russia and its lack of corporate governance. George Dallas, the managing director in charge of the project, assumed this would be an emerging markets issue with the least interest in these sort of ratings in the US. Enron changed the picture, he says, leading to renewed interest in corporate governance there.

The fraud and mismanagement at AIB and Enron are perceived in different ways in different regions. Mr Breuer dismisses them as cases that have not affected the bank's attitude or its code of conduct. Mervyn Davies, group chief executive officer of Standard Chartered Bank, says there are moral lessons to be learned. "Basically, you must ensure that your values and ethics are clear and stick to them even when you are under revenue pressure," he told The Banker. "Both companies changed their business model dramatically and got into areas they had not done before without fully understanding the risks attached to those activities."

And in Thailand, on the back of both cases, there is a view that the developed world's Anglo-Saxon model of banking - continually held up by the World Bank and the IMF as an example to follow - is not as perfect as was once thought. "If we believe that the Anglo-Saxon model is the one that depends on transparency and accountability, there are problems with enforcement and putting in place an appropriate incentive structure," says Khunying Jada Wattanasiritham, president and chief executive officer of Siam Commercial Bank, the fourth largest and most profitable bank in the country. "As we have seen, one could legally find a way to circumvent good regulations. When we apply such a model in developing countries, there are also problems related to the quality of regulators and the depth of the market."

Development dilemma

Many banks, though, are moving into new activities and emerging markets in a search for growth. Yet the standards of behaviour expected of banks by stakeholders have risen, making this a doubly difficult challenge. Michel PŽbereau, chairman and chief executive of BNP Paribas, dismisses the need to reconcile different moralities from different regions of the world. "It is important for a truly international bank like BNP Paribas to have a common set of values which all employees share. We have four values which symbolise BNP Paribas' goals and its multicultural nature: commitment, ambition, creativity and responsiveness. They fit all countries in which we are active," he says. Standard Chartered is more realistic.

Mr Davies says the bank, which earns its revenue from emerging markets, faces more difficult ethical dilemmas than those operating in developed countries. "Cultures and ways of conducting business vary tremendously from country to country. We face these challenges through having a high standard of conduct for business throughout the world based on several non-negotiable principles," he says, adding, however, that: "In implementing these group standards we always have to be aware of local laws and cultures."

As an example, he mentions that the bank supports diversity and non-discrimination and the International Labour Organisation's core conventions. However, to operate in Malaysia, companies are legally obliged to discriminate positively in favour of indigenous Malays.

Mr Davies is also attuned to charges of neo-colonialism from developing countries when developed markets impose higher standards on emerging markets than on themselves. "For example: Ethical Investment Research Service, which administers FTSE4Good, is discussing whether more stringent human rights requirements are applicable for companies operating in particular countries with poor human rights records than those operating solely in the UK," he notes. Even on a day-to-day basis, banks operating in emerging markets face more complicated ethical questions.

Khunying Jada says: "In a developing country, a bank, especially a local bank, cannot get away from dealing with poor customers. There could be business opportunities with this customer segment - micro financing or transfer and remittances from workers in Bangkok or abroad - but they may have high risks and do not generate profits. For social benefits, banks may have to provide such services with a subsidy. At times, local banks may also have to assist the government in carrying out its policies."

This goes beyond the scope of local community projects and sponsorship projects undertaken by banks in the developed world. But even within the developed world there are major differences between continents, specifically between the US and Europe. For the Europeans, "we try to balance the triple-P bottom line: people, planet and profits," says Wouter Scheepens, responsible for sustainability policy at ABN Amro, regarded as one of the more advanced banks in this area. "Sustainable development and making money go hand in hand to create shareholder returns in the longer term."

But the divide between European and American bank philosophies is a reflection of culture. In Europe, especially northern Europe, there is "more demand [for an ethical dimension to investing], a more collectivist ethics and tradition, while America is more about the rugged frontier type where collaboration is less entrenched than the individual. Environmental and social issues need collaboration," explains Mr Kiernan.

An example of this is ABN Amro's forestry policy, which came about on the back of NGO accusations some years ago that it and other Dutch banks were financing destructive palm oil plantations in Indonesia. The bank sat down with the NGOs and hammered out a policy on forestry that more or less met the wishes of both parties involved. The stricter criteria applies to new projects. But, realistically, for those already on the books, the bank will consider them when they come up for review rather than undertaking a complete overhaul of all outstanding loans.

Ethical issues as part of a bank's business are here to stay and they will grow. Whether or not it is fair to place so much responsibility on banks is irrelevant. It is not enough for banks to look on them as necessary costs for damage limitation. Nor is it productive to see the issues as forced on them by regulators and the law. There will not be a business benefit every time - although more often than not, there will be - and ethical dilemmas will not go away since banking is fraught with complexity.

But banks need to be more proactive on this front and to publicise what they do. In the end, perhaps author Doris Lessing's words offer the best advice for banks when faced with this topic: "Whatever it is you are meant to do, do it now. The conditions are always impossible."


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