Financial Ethics Failures and the Crisis of Accountability
Financial Ethics and Accountability Failures
The Roots of the Financial Crisis
Over the last decade, numerous examples have shown how values and ethics have been ignored in the financial world.
The risky decisions and lack of values are cited as principal causes of the crisis, according to the Laroisière Report. The lack of values, often driven by wrong incentives for executives, led to the mispricing of risk and an increase in leverage. There was also a complete lack of transparency.
The increase in the market for derivatives also increased the “appetite for risk,” and investors often seemed unaware of the dangers of these decisions or were misled about them.
Systemic Failures and Lack of Supervision
The US Congress Report, created to examine the collapse of the financial system, concluded that there were significant failures in supervision, corporate governance, and risk management. It also expressed that the combination of excessive borrowing, risky decisions, and lack of transparency proved fatal, resulting in a systemic breakdown of accountability and ethics.
Major Financial Scandals: LIBOR and Forex Manipulation
In 2013 and 2014, it was discovered that several large banks falsified their contributions and effectively manipulated the EURIBOR and LIBOR benchmark rates to maximize their short-term benefits. Banks implicated included Barclays and Deutsche Bank. This triggered changes in how these benchmark indices are calculated.
Related to this is the Forex scandal, a financial scandal in which banks colluded, for at least a decade, to manipulate exchange rates for their own gain.
Ethical Issues in Bail-out Plans: Moral Hazard
Bail-out plans introduce other ethical issues that require attention. If companies know that if they are large enough, the government will rescue them, their main aim will be to carry out “run-for-size” strategies to become “too-big-to-fail.” This encourages them to take riskier decisions, leading to moral hazard—where managers carry out actions knowing they may result in negative effects for someone else, as the risk is socialized.
Offshore Financial Centers (OFCs)
Offshore Financial Centers are also critical in the discussion of finance and ethics. They provide financial services to non-residents and possess a financial industry disproportionate to their population size. To attract foreign capital, they offer light controls and deregulation. Consequently, these financial centers act as black holes for global financial supervision and undermine financial stability. They are also thought to be havens for illicit wealth derived from developing countries, tax-avoiding companies, or even criminal organizations.
Insider Trading
Insider trading is the use of privileged information for personal benefit. This practice, apart from being unethical, is also a criminal action. Securities Commissions are in charge of supervising this, but it is often difficult to prove when it occurs.
Ponzi Schemes: Financial Fraud
Ponzi schemes are financial frauds in which the return paid to investors does not come from specific profits, but from the investors’ own money or from the money paid by subsequent investors. To attract investors, they offer returns (in the form of interest rates) well above the average for similar investments. The early stages of these frauds normally seem like an ever-lasting flow of money. While these frauds are usually detected by authorities, if not, there are two typical outcomes:
- The promoter flees and steals the money.
- The scheme collapses because it cannot find new investors, or because previous investors ask to withdraw their money.
Two recent cases of Ponzi schemes include the Madoff case (2008), where the fraud went on for more than 15 years and over $50 billion was evaporated. Another example is the Albania case in 1997, where 50% of the country’s GDP was invested in these frauds.
The Rise of Ethical Banking
After these examples where values and ethics were ignored, it is important to mention the concept of ethical banking. Even in countries where the disintermediation process has advanced, banks still play a major role. For example, they could restrict access to funding for socially damaging programs and facilitate easier and cheaper funding for socially and environmentally friendly activities. To promote this, the Global Alliance for Banking on Values was created in 2009. Their common focus is to create a Triple Bottom Line: for people, planet, and profit.