Three reasons why impropriety in financial institutions are no surprise and nothing will change

1. Homo Economicus or economic man mindset

The Australian review of the banking and finance industries, under Justice Kenneth Haynes, will almost certainly recommend changes to corporate culture, as has become the norm in similar reviews in recent years. Culture is a complex set of relationships, norms and attitudes that are hard to change. At the root of culture is the mindset of what motivates humans, themselves and clients, which for people in the financial industry is homo economicus. This is a mindset that views humans as rational, self-interested agents who pursue measurable financial outcomes or near equivalents, like status or power, which are believed to contribute to financial rewards. Ethics, social responsibility and other considerations that are hard to convert into financial consequences in ex-ante calculations tend to get ignored. The homo economicus mindset leads to the types of norms and attitudes that result in bending of rules to hit targets and achieve bonus and incentive structures reinforce these. Business, including financial institutions, do donate large sums to social causes, sometimes in very public displays for reputational benefits, but often quietly and unheralded. These contributions are like business people described as “weekend Christians” (or Muslims, Jews, etc.), who practice religious values, such as compassion and virtue, with family, friends and others on the weekend but not in the business from Monday to Friday.

2. Incentive structures are full of moral hazard.

From the bottom to the top of the industry, incentives in the finance industry reward behaviour that is not in the best interests of clients. Bonuses are tied to sales of products, not the service provided or the performance of the products. This is consistent with the homo economicus mindset and amplifies the effects. Financial rewards are the main driver for people employed in the finance industry; their value goes beyond the dollars received. The size of one’s bonus confers status and self-esteem. When people start to define themselves in terms of financial rewards, there is too much at stake not to hit the target. Behaving unethically by bending the rules or ignoring client needs become a small price to pay, and then only if detected, for maintaining status and self-worth. Business leaders often feel under attack from people who “do not understand business”, for example, how tax cuts lead to jobs. However, for most people, that is not the issue. They look at the size of bonuses paid, compare them to their pay, and cry foul! This judgement is amplified when those bonuses are earned through unethical practices. If a business wants respect, it needs to behave respectfully and fairly.

3. Rewards in the financial industry operate something like a Pyramid Scheme.

Large numbers of staff at the bottom of the hierarchy sell products and services for which they receive bonuses. The revenues are accumulated at the next level where fewer managers are paid larger bonuses and so on from level to level until we reach the senior executive team, who are paid large bonuses. But for what? It cannot be for their direct leadership because they have little to do with the frontline staff. Presumably, they are rewarded for creating and enforcing the systems and processes, including the incentive system, that guide the behaviour of staff at lower levels of the organisation. It is rarely the case that senior managers or board members are sacked or lose their bonuses when scandals break. It is more common for local staff and managers to be labelled as bad apples, or for specific systems to be identified as needing change. Often, the blame falls to the designers and managers of specific processes and staff, and not on those at senior levels who have the ultimate responsibility for all systems and processes and the consequential behaviour of staff.

Justice Haynes has a big job, not in identifying problems in financial institutions, in fixing them. For more on ethical failure in the finance industry, go to the CAANZ report, prepared by staff from Cognicity and the Centre for Ethical Leadership

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