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Last Updated : Oct 15, 2018 10:10 AM IST | Source: Moneycontrol.com

Opinion | The role of culture and values in financial crises

We always ignore culture and values and work towards the balance sheets only to be surprised in the next financial crisis

Moneycontrol Contributor @moneycontrolcom

Amol Agrawal

The crisis in Indian banking and now at IL&FS is a case of declining culture, value and ethics, as much as it is about deteriorating balance sheets. These institutions were so far led by people of high eminence, but all we see is higher compensation and benefits for top management amidst sharply declining governance standards.

India is not alone in this. The common theme of misconduct and bad behaviour is one that plagues financial markets globally. Indeed, if there is one thing common among major economies today, it is some form or other of such a crisis, which is mostly more than mere bad loans.

Amartya Sen presents this problem of culture in a fascinating 1991 lecture titled Money and Value: On the ethics and economics of finance: How is it that finance, which is otherwise such a useful economic activity, has been viewed as morally being so dubious? Right from Polonius who advised his son "neither a lender or a borrower be" to Jesus driving moneylenders from temple to Islam considering usury (lending on interest rates) as a sin to Shylock's portrayal in Shakespeare's 'The Merchant of Venice', the dubiousness of finance is a common theme. Yet, as Sen notes, without finance, no progress would have been possible. Whether it was industrial revolution or renaissance, the helping hand of finance was needed. What explains this dilemma?

Sen, quoting Immanuel Kant, argues that the key ethical issue is the relationship between duties and consequences. It is always tempting to see finance in its "immediate appeal" and value short-term gains over long-term stability. The usual thinking is that duty and consequences are independent, but they are not and one has to eventually pay for any duty not conducted ethically. He picks a case of insider-trading where the usual thinking is that it impacts only traders. However, it clearly has much wider ramifications on the confidence in the financial markets once the case is revealed to so-called outsiders. Even those who choose to run banks only for shareholders profit maximisation have a fiduciary responsibility towards depositors.

It is not as if Sen has said anything new as these views have been shared by quite a few philosophers of the past. Sen himself refers to Kautilya, Aristotle and Adam Smith who raised concerns about financial activity. Given that these concerns were understood by all these philosophers, it is amazing how little the core of finance has changed despite all the talk of innovation and change. In most financial crisis of past, this decline in culture and values is as central as deteriorating balance sheets. But we always ignore the former and work towards the latter only to be surprised in the next financial crisis.

We were surprised in the 2008 crisis as well. It started with pointing at excessive compensation levels in the financial services industry. The industry even showed the temerity to distribute the initial bail-out money as bonuses. Investigations showed how investment bankers, credit rating agencies and analysts had set up the game in such a way that all gains were theirs and losses were socialised. Then we saw rigging of LIBOR interest rates, the reference for pricing most financial contracts across the world. LIBOR is computed by polling prestigious financial firms and they had cartelised to report lower rates than the actual which enabled them to report lower interest costs and higher profits. These revelations are leading to wide-scale changes in setting the reference or benchmark interest rates, a development which has mostly been ignored by the media.

This misconduct raised public opprobrium forcing various governments to conduct inquiries. The US Financial Crisis Inquiry Commission said one of the factors responsible for the 2008 crisis was the systemic breakdown in accountability and ethics. The New York Fed has made governance and culture reform one of its core agenda. In a white paper, its researchers have cited robust culture as a kind of additional capital to the organisation’s capital base, which can help in times of financial crisis.

The United Kingdom set up a Financial Conduct Authority to regulate this very behaviour and the Bank of England officials have raised concerns over conduct and culture in multiple speeches. An Icelandic working group on ethics and finance found that "the most important lessons to draw from these [crises] are about weak social structures, political culture and public institutions." Similar findings were established by central banks and inquiries in Ireland and Netherlands too.

An Australian commission which presented its interim report on September 28 blamed the pursuit of short-term profit at the expense of basic standards of honesty and lack of enough punishment for the ongoing misconduct in banking services. This has prompted New Zealand to investigate too.

Thus, it is not the question of 'if and why culture matters' but 'how can we reform the culture,' as Kevin Stiroh, Executive Vice President of the New York Fed, said in a recent speech. He called for bankers and regulators to look at behaviours and outcomes from multiple perspectives as no one perspective will help address this "highly complex problem". Philip Lane, governor of Central Bank of Ireland says that as each firm has its own culture, no supervisor can prescribe culture. But regulators can monitor and assess culture within firms which are leading to higher risks that eventually harms customers.

In light of the IL&FS and banking crises, the question is whether India’s policymakers will also look at this missing culture in India’s financial services. It will help us better reflect on the ongoing financial problems than is being done at the moment.

(Amol Agrawal is faculty at Ahmedabad University. The views expressed here are his own.)
First Published on Oct 15, 2018 10:10 am
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