Ethical Considerations of the Banking Industry - Coursework Example

Banking: An ethical dilemma? Introduction The idea of ethics in banking has always been an important consideration. An ethical dilemma arises when a decision that has to be made involves a conflict at personal, interpersonal, institutional or societal level or raises issues of rights or moral characters (Banks, 2012). In the banking industry, Sarbanes Oxley act addresses not only behaviour of the corporate executives, but also of all employees, including tellers, accountants, loan officers, marketing directors and customer service executives. It has been observed that in each employee group, significance of ethical dilemma is formidable. This paper attempts to discuss the ethical dilemma, which can be faced by any bank in its operational activity, both in the external environment and conflicts of interest arising within the organization. The ethical dilemma that arises within working environment of a bank is more severe, as these systematically weaken the vibrant economic system of a country. The concept of ethical dilemmas had become more pressing during the recent financial crisis, as it was strongly believed that unethical conduct of the financial industry in general and banking in particular, had led to global economic meltdown. The purpose of this paper is to discuss ethical considerations of the banking industry and compliance of the banks to these ethics in order to understand the way banking industry faces the challenges of ethical dilemma. The last section of the paper discusses few of the policy recommendations, which can help to resolve issues of ethical dilemma faced by the banks. Importance of ethics in bank A vibrant banking industry is extremely important for proper functioning of an economy. This makes the issue of ethical considerations in banking an extremely relevant topic. Banking sector merely acts as an intermediary between the depositor and creditor. A respectable bank is expected to be honest, exhibit integrity in its transactions, social responsibility, accountability and compliance to promises (Solomon, 1992). The ethical dilemma for banks arises because they have to work in grey area of ethics and often under high level of pressure. Sometimes, in order to gain financial benefits, banks often end up making decisions that undermines ethical issues, which is the root cause of the problem. There have been numerous cases where banks have been involved in scandals revolving around acceptance of bribes, advancing loans to unfit customers and lending to connected parties, which may be considered as unethical on part of the bank. In a research conducted by Carse (1999), it was observed that bribery and corruption are becoming ingrained in the institution of banking and the line between legitimate and illegitimate is gradually getting blurred. As banking is essentially a business of trust, this makes the banks responsible for all of their actions towards customers (Chowdhury, 2011). The customers, on the other hand, do not have perfect information about banking transactions. Hence, it is difficult for them to ascertain the nature of unethical conduct, even when it is practised by the bank. Conflicts of interest: External environment The following cases represent the ethical issues, which often lead to the ethical dilemma faced by banks: Unethical practices: Like in any other industry, it is acceptable that bankers have the full right to maximize their profits, when they loan out money, which is trusted to them by the depositors. However, there are instances when banks end up charging ultra high interest rates, abusive commissions and high credit charges, which are beyond acceptable standards. This is a classic issue of ethical dilemma faced by a bank, where it has the authority to either charge or not charge higher rates, but the final decision is taken by the authority and actions taken are often against the welfare of consumers (Fidelis International Institute, 2014). Speculative Banking: The case of speculative banking can be treated as another dilemma that is faced by banks, as the final call about the decision it makes rests with the bank (whether to go ahead with the deal or cancel it). Often banks are found to be engaged in high-risk, high-return type of clients. These situations are particularly tricky because it involves the decision regarding whether the bank should go ahead with the investment and invest speculatively in risky assets for obtaining high returns in the short run. The problem with such an investment is if calculations on part of the banks go slightly wrong, then this results in massive destruction of wealth, leaving both the parties in a worse-off situation (Faruqi and Bery, 1994). Financing controversial projects: When banks are financing projects based on military and arms, then there are direct implications of human rights violation. Funding such projects may not be considered as entirely wrong, given that developing defence structure is essential for every country. However, most of the money obtained from these institutions is used for manufacturing weapons of mass scale destruction. Several financial institutions openly own shares of the manufacturers of these ammunition companies (examples include GenCorp, Lockheed Martin and Textron). This seriously puts a question on the role of banks, where they act as the creditor to these institutions. The huge profits that can be earned by banks pose a question for the authorities of whether they should take up such projects or not. Financing companies which lacks CSR: Banks are often found to finance companies in third world countries, which violate various ethical considerations, like, using child labour and forwarding bribes to corrupt government officials. This may not be the responsibility of the banks, but it does not free them from the moral wrong involved in supporting these activities (Hill, 2008). Ecological issues: Banks are often found to be involved in projects that may adversely impact the environment. There are a host of organizations that are involved in activities like, building dams, which displaces people from their homes, unsustainable harvest of natural resources and extraction of fossil fuels, that indirectly becomes a part of corporate social responsibility of banking industry as a whole (Hill, 2008). Apart from the external environment that has been presented, where the banks can face ethical dilemma, the same can be faced in internal day-to-day working of these institutions. For instance, a particular employee (superior in rank) accepts high bribes for doing his job. Even though a junior colleague knows about this problem, whether to raise this issue to a higher authority can pose an ethical dilemma for the junior employee. Often these problems remain ingrained within the organization. Conflicts of interest: Internal environment This section of the essay highlights various conflicts of interest, which arise in the day-to-day functioning of financial institutions. There are four broad sections that underline the types of conflicts of interest in the financial industry as a whole. They are underwriting and research in investment banking, auditing and consulting in accounting firms and credit assessment and consulting in the credit rating agency and universal banking. Underwriting and research in investment banking: Investment banks often take up both the tasks of underwriting and research of the companies for which it issues securities and the investors to whom it sells these securities. They do this in order to achieve economies of scope. Information which is gathered for one task may be used for another task as well. This action is itself unethical because two client groups, which the investment bank is serving, have opposing interests. The issuer of securities wants optimistic research, while the investor of securities wants an unbiased one. Both of these groups receive the same information because the investment bank harbours strong biasness towards the issuer company. This is because if it presents a very neutral view, then the organization will approach any other competitor bank, who will present more favourable reviews for the company. For example, Morgan Stanley, which had published a report in Wall Street journal, where they stated to have never displeased their clients (Anon, 2003). Auditing and consulting: The primary function of any auditor is to reduce information asymmetry between the shareholders and firms’ managers by scrutinizing book of the firms. The conflict of interest leading to an ethical dilemma can arise when the accounting firm accepts both the tasks of auditing and management advisory services. The latter task undertaken by the firm has a clear conflict of interest with the former one. This is because clients often threaten auditing firms by taking their services to other competitors, if results are not properly manipulated in favour of the clients. This can result in the firm coming up with skewed results (Parkash and Venable, 1993). Credit Assessment of the credit rating agencies: The credit rating agencies are also faced with the conflict of interest and this is particularly harmful for investors. This is because investors rely to a great extent on the credit rating provided by these agencies and their investment decisions are dependent on the same. The credit rating agencies are paid by firms to provide ratings to them. So, there are high chances that these agencies might manipulate the results to favour clients on exchange of the huge sum that they receive for their service. This situation is aggravated when the same agencies provide ancillary services, like, consulting for their clients. The credit rating agencies often succumb to the greed of drawing more clients by providing favourable rating to the latter (Puri, 1996). Universal Banking: The concept of universal banks heightens the conflicts of interest among organizations. Universal banking can be referred to as a situation, where an organization acts simultaneously as a commercial bank, an investment bank as well as a financial institution. This practice was previously repealed by the passing of Glass-Steagall Act in 1933. Even so, in recent times, this practice has been emerging again and organizations are facing conflicts of interest, thereby leading to an ethical dilemma. In this situation, employees of various departments of the same company may try to obtain skewed results from other departments in order to retain clients and improve the reputation of that particular department. For example, a manager of a particular bank can persuade existing clients to buy securities of a client company, which may not be very safe. There can be even instances, when the bank tries to limit losses from a poor quality initial public offering by selling them to the trustworthy customers. The problem of asymmetric information can also play a substantial role in fooling unsuspecting customers. Asymmetric information arise when the bank has internal knowledge about the client firm (with a large amount of outstanding loan or high chances of credit risk that may lead the company to bankruptcy), but still uses its underwriting department to issue securities for sale to the public, who do not share this knowledge. Another common practice that is exercised by banks is that of advancing loans to unfit customers. This includes advancing loans to customers without proper background check, which increases the chance of default on part of the client, but the bank may be focused more on the short-term gains that it can obtain by disbursing the loans. If the bank sells products like, insurance services, then it has high chances of influencing customers into buying the product, irrespective of actual need of the client (Mishkin, n.d.). Implications The most severe impacts of unethical practices of the banking industry, in recent years, have been manifested in the global financial crisis (Russel, Dortch, Gordon and Conrad, n.d.). It has been established that the subprime lending crisis is the combination of unethical predatory lending practices and frauds done by financial and banking giants. This is because the American banks engaged in selling loans with initially attractive clients, without proper verification of their background. This becomes a case of fraud as these banks know beforehand that the clients might default and still they offered loans to the latter (Deflem, 2011). The crisis which began in America took almost no time in spreading its impacts in the developing countries, given the intricate integration between the countries in the contemporary world. Remedies In the aftermath of the global financial crisis, there has been increasing concerns about policy recommendations, which are needed to rectify the situation. Increasing importance is now being assigned to transparency in the working of financial institutions, inclusive of credit rating agency, commercial and investment banks and other financial institutions. The regulatory authorities are gearing up for stricter measures, which will enable financial institutions to come up with transparent approaches. Corporate governance can be another way through which fraudulent practices of these institutions can be reduced. Functioning of the markets is constrained if organizations working in it do not have proper corporate governance. The role of auditors is particularly important in this regard, as is specified in the Sarbanes Oxley Act. Though every existing financial institution is required to present disclosure reports, yet this imposition does not bound the institutions to do so transparently. In this regard, role of the supervisory and regulatory committee becomes extremely important as these bodies have the required power to make institutions fully accountable to investors and other shareholders. Government supervisors can be particularly helpful as they have strong monitoring power on the internal actions of firms. Increasing competitiveness of the credit rating agencies and greater regulation of them can increase buoyancy in the financial markets. If the ratings from these agencies are accurate, then investors can have a safer investing environment (Mishkin, n.d.). Conclusion This essay has presented an in-depth discussion about the ethical dilemma that is faced by banks in their day-to-day functioning. It has been established that ethical considerations are particularly important for banks because banking is a business of trust. The depositors trust the bank with their money and it is the bank’s primary responsibility to be fully accountable for this money. Over the years, financial systems all over have become more and more complex. The ethical dilemma that can be faced by banks in the external environment has revealed various situations, where the banks must take the final call regarding their actions. For instance, a bank can fund activities like, military funding or environmentally adverse projects, which may violate human rights. In these situations, the objective of financial gains is in direct conflict with ethical considerations. Perhaps, more serious than this issue is that of ethical dilemma, which is faced by banks in their internal working. The functions of investment banks have revealed that actions taken by these banks in an ethical dilemma can hugely undermine the social interests. The concept of universal banking, in the present scenario, aggravates the ethical dilemma and banks often seen to succumb to the lure of financial gains. The recent global economic meltdown has been the direct result of excessive speculative banking by uncontrolled actions of the investment banks and their excessive greed. The policy recommendation shows that tightening of norms and regulations by the regulatory authority can improve the given situation. Reference List Anonymous, n.d., 2003. Conflicts of Interest in the Financial Industry. [pdf] International Center for Monetary and Banking Studies and Centre for Economic Policy Research. Available at: [Accessed 7 February 2014]. Banks, C. 2012. Criminal Justice Ethics: Theory and Practice. London: Sage Publications. Chowdhury, M. M. F., 2011. Ethical issues as competitive advantage for bank management. Humanomics, 27(2), pp. 110-115. Deflem, M., 2011. Economic crisis and crime. London: Emerald Group Publishing. Faruqi, S. and Bery, S. K., 1994. Financial sector reforms, economic growth, and stability: experiences in selected Asian and Latin American countries. Geneva: World Bank Publications. Fidelis International Institute, 2014. Ethical Issues facing the Banking Industry. [pdf] Fidelis Institute. Available at: [Accessed 7 February 2014]. Hill, C. V., 2008. South Asia: An Environmental History. California: ABC-CLIO. Mishkin, F. S., n.d. Policy Remedies for Conflicts of Interest in the Financial System. [pdf] Bank of Canada. Available at: [Accessed 7 February 2014]. Parkash, M. and Venable, C. F., 1993. Auditee Incentives for Auditor Independence: The Case of Nonaudit Services. The Accounting Review, 68 (1), pp: 113-118. Puri, M. 1996. Commercial Banks in Investment Banking: Conflict of Interest or Certification Role? Journal of Financial Economics, 40 (3), pp. 373-40. Russel, K., Dortch, M., Gordon, R. and Conrad, C., n.d. Ethical Dilemmas in the Financial Industry. [pdf] Sage Publications. Available at: 3 [Accessed 7 February 2014]. Solomon, R.C., 1992. Ethics and excellence: cooperation and integrity in business. New York: Oxford University Press. Read More