Integrity in Financial Services


Trust and Integrity in Banking

John Boatright is Professor of Business Ethics in the Graduate School of Business at Loyola University, Chicago, USA.  He has been Executive Director and Past President of the Society for Business Ethics, author of the books Ethics and the Conduct of Business and Ethics in Finance, and the editor of the volume Finance Ethics: Critical Issues in Theory and Practice.

John was the first person to submit a paper for the event in late 2010 and its receipt was particularly well received given the economic crisis which followed a banking crisis and leadership deficit in Ireland, necessitating a visit from those helpful people in the International Monetary Fund, European Central Bank and European Union, now referred to as ‘the troika’.

John and his photographer wife Claudia were one of the most pleasant and cheerful attendees at the event. Whilst Claudia’s photography managed to capture extraordinary angles of some of Dublin’s more beautiful and historical buildings, the angles of perception he displayed of banking integrity and notably its failings were no less sharp and penetrating.

Like Dublin and indeed Ireland, one of John’s key points was that the nature of banking has changed considerably since even the 1980s and this created wide ranging challenges well beyond the traditional reliance on the integrity of bankers doing the right thing by the customer.

John opened by stating that trust and integrity are highly valued moral goods, not only in banking but in business generally, with little commercial activity possible without them.  Many scandals and crises, including the current financial collapse, are blamed on the lack of trust and integrity.

However he said it was too easy to fall back on pious platitudes about the need for trust and integrity in banking and earnest exhortations for more of these qualities. He proposed a more rigorous treatment would consist of answers to questions about what is morally required of bankers and why these requirements arise.  Banking is different from other business activities in morally relevant ways, and so he said we must consider the roles that trust and integrity play in the distinctive practices of banking.

John believed the world of banking in the twenty-first century bears little resemblance to what it was, even as recently as 1980, something he would conclude his talk by discussing.  He cited Laurence J. Kotlikoff observation in his book Jimmy Stewart Is Dead, the kind of bank described in the classic movie “It’s a Wonderful Life” no longer exists.  Kotlikoff suggested that a movie about banking today would be titled “It’s a Horrible Mess.” Even if this view is unnecessarily harsh, John suggested it was evident that modern banking has produced an unusually severe crisis and threatens to do so again and again.

He stressed the failures in the banking system were not due solely to a loss of integrity and trust, and their restoration would not solve all the problems.  However, trust and integrity are still important in modern banking.  So John proposed to examine what trust and integrity mean in this new world of banking and what role they play.

The first issue he then addressed was that, although banks are businesses, their distinctive character is evident in many ways, including how they are chartered, governed, regulated, and operated.  Being a banker is commonly considered a special role that invites admiration, as well as some suspicion and resentment.  And the banking system is generally conceived as both a necessity for an economy and a danger to society.

Another difference lies in banks unusual market characteristics, A key element of markets is the use of contracts as the chief device for executing discrete transactions.  Contracts have the important moral property that they do not depend for their force on trusting the other party.  With legally enforceable contracts, we can engage in exchanges or transactions with anonymous parties with the confidence that they will perform as expected.  In the absence of a well-functioning legal system, however, with unreliable contract enforcement, trust not only becomes becomes critical but can also be seen as an alternative to legally enforceable contracts as a means for engaging in market activity.  We must trust others in situations where reliable contracting is not feasible.

John suggested that he same point applies to the concept of fiduciary duty, which is of critical importance in banking.  Fiduciary duty is explained, by some, as a device for filling gaps in incomplete contracts.

Traditionally, banks served as intermediaries in fulfilling four critical functions in an economy.  These are (1) payments, providing a means for transfer money from one party to another; (2) savings, providing a means for people to safely place money that is not needed for current consumption; (3) lending, making loans from savers’ deposits to customers in need of funds for consumption or investment purposes;  and (4) risk bearing and shifting.  In particular, banks bear the risk involved in using savers’ deposits to make loans to borrowers.

A second distinctive feature of banking is that it does not merely provide services and products in a functioning economy; it is an essential component of an economy that enables it to function.  The banking system has been compared to the heart in a body, which circulates blood throughout the body and thereby sustains the life.  Just as a body could not function without a heart, so an economy cannot function without a banking system.

This reliance of an economy on a banking system has led some commentators to speak of banking as a utility.  Mervyn King, the Governor of the Bank of England, recently called for a separation of “utility banking” and, what he labeled “casino banking.”  This utility aspect of banking creates another role for trust: to assure everyone that the essential services and products of the banking system will be maintained. Unlike utilities such as water electricity and gas, banks are privy to a great deal of sensitive information, which, in fact, gives rise to the importance in banking of duties related to confidentiality and privacy and the trust that these duties require.

Although agreeing trust and integrity were of critical importance, John suggested that, as well as morality generally, they had two crucial limitations.  First, they are difficult and costly to inculcate.  Extensive social resources must be expended to ensure that all individuals in society or an institution, such as a bank, are trustworthy and act always with integrity. Second, trust and integrity, along with morality generally, are unreliable.  Trust can easily break down or prove illusory, and even people with integrity can sometimes act wrongly.  If our goal is to ensure that banks and the banking system operate well, it would be prudent to examine all the means available for this purpose.

John then outlined four major means for ensuring that banking operates well and fulfills its main functions: market forces, government regulation, institutional design and ethics or morality.   First, competition among banks for customers’ deposits and loan business provides banks with powerful incentives to assure these customers of their trustworthiness and integrity.

Second, banks have long been subject to close government regulation, which is due not only to deposit insurance but also to the role of government in the currency and credit systems. Unlike most businesses, where regulation serves mainly to protect the public, banking could not easily exist without close association with government (perhaps too close in Ireland).

Third, John cited economists such as Douglass North who explained the importance of the design of institutions in advancing economic development and channeling market activity. Trust and integrity can be facilitated, for example, by the governance structure of banks (such as partnerships versus public ownership); by the separation of functions (such as commercial from investment banking, of banking from insurance, and mortgage origination from securitization); and by organisational features (such as the shielding of analysis from bank lending and the compensation and bonus structures).  In banking, institutional design matters, and many problems can be solved by getting the design right.

Finally, ethics or morality is a major factor in guiding and controlling human behaviour, which operates in banking and other economic activity not only by providing an internal motivation for right action but also by means of formal codes and compliance programs.  For example, an individual banker may be guided in making a right decision not only by a personal conception of right and wrong or an internal “moral compass,” but also by consulting a bank’s code of ethics, mission statement, or other policy documents.

John said it was not his intention to minimize the role of ethics or morality in banking but to stress two points.  One is that ethics or morality is not the only factor in guiding behaviour.  Markets, government regulation, and institutional design are non-exclusive alternatives that should be combined with ethics or morality to form an effective deterrence and control system.  The second point is that ethics or morality has limitations as a means OF deterrence and control.  As a part of a complete system, it is difficult and costly to implement and is of uncertain reliability.

John then discussed two very apt quotations. He said a caution against moralization is provided by what has been called Hanlon’s razor, which is “Never attribute to malice that which can be adequately explained by stupidity.”

To this, Douglas W. Hubbard (The Failure of Risk Management) added: “Never attribute to malice or stupidity that which can be explained by moderately rational individuals following incentives in a complex system of interactions.”  The challenge, then, in analyzing the role of trust and integrity in banking or the current financial crisis, is to separate out the roles played by malice, stupidity, and moderate rationality and perverse incentives in a complex system of interactions.

To correct the failings that arise in banking and our financial system generally, John suggested we need the opposite of these, namely virtue, wisdom AND better markets, regulation and institutional design.  Trust and integrity are included in virtue, although they also are a part of wisdom as understood by Aristotle in the form of phronesis or practical wisdom.  We need bankers who are virtuous and practically wise, in Aristotle’s sense, but we also need better markets, regulation, and institutional design and an understanding of how all these elements should be balanced and fitted together.

He quoted President Ronald Reagan frequently said in connection with arms control with the Soviet Union , “Trust, but verify.”  This phrase emphasized the point that trust alone is inadequate and is best combined with other means of assurance.  Indeed, the best system might be one that does not require trust at all.

John then concluded his discussion of trust and integrity in banking by remarking how banking had changed over recent decades. He suggested that banking has been transformed recently by three interrelated developments.

The first was that banking has experienced a division of the “value chain,” in which different banking functions are now available from a variety of different special purpose institutions, even supermarkets. Banks now hold a much reduced share of savers’ deposits and borrowers’ loans.

Second, the banking industry has been increasingly consolidated by mergers and acquisitions (some forced by failures) into a small number of very large, comprehensive megabanks which offer many services under one roof. The focus has shifted to the few services that are the most lucrative, relying more and more on developing securities, such as collateralized debt obligations (CDOs), and specialized derivatives, and on trading for their own account, usually leveraging their capital by borrowing short-term to finance their large portfolios.  He quoted from Simon Johnson’s book 13 Bankers:

For Wall Street’s megabanks, business as usual now means inventing tradable, high-margin products, using their market power to capture fees based on trading volume; taking advantage of their privileged market position to place bets in their proprietary trading accounts; and borrowing as much money as possible (in part by engineering their way around capital requirements) to maximize their profits.

John said the third development is often called “financialization,” in which finance has come to assume an increasingly important role in people’s lives as the major source of their well-being and securityhe quoted from Managed by the Markets: How Finance Re-Shaped America where Gerald F. Davis observed that people’s welfare, previously secured by organisations, usually a corporate employer, is now sought in financial markets:

As large corporations have lost their gravitational pull on the lives of their members, another orienting force has arisen: financial markets. .  The bonds between employees and firms have loosened, while the economic security of individuals is increasingly tied to the overall health of the stock market.

People not only depend more on finance for the sustenance of their lives but have had their thinking shaped by it to produce, what Davis calls, the “portfolio society.”  Quoting further:

As financial markets extended their reach beyond the corporate world, more aspects of social and political life were drawn into their rhythm. . . . What emerged can be called a portfolio society, in which the investment idiom becomes a dominant way of understanding the individual’s place in society.  Personality and talent become “human capital,” homes, families, and communities become “social capital,” and the guiding principles of finance spread by analogy far beyond their original application.

John suggested these three developments—the division of the “value chain,” the new “business as usual,” and financialization or the portfolio society—have significant implications for trust and integrity.

First, financial activity has come to consist more and more of impersonal transactions among anonymous parties in a complex system, so trust and integrity as traditionally conceived play less of a role.

In a situation where trust is placed more in the whole system that in specific people or institutions, individual responsibility is not diminished; indeed, it is needed more than ever.  However, the trust that we place in people and institutions extends beyond their performance of traditional banking functions and includes their responsibility to build and maintain the financial system.  What is morally required from bankers today, then, is a sense of responsibility for the role that they and their own institutions play in the functioning of the financial system

Second, with the rise of megabanks engaged in the production of large volumes of derivatives and in highly-leveraged proprietary trading comes considerable systemic risk.  This risk is exacerbated by the implicit subsidy that large banks receive by being perceived as “too big to fail” since investors believe, rightly or wrongly, that the government will come to their aid in the event of distress. The result is a substantial moral hazard problem.  In addition to posing a systemic risk for society, which is exacerbated by moral hazard, banks are also engaging in a shifting of risks that they formerly assumed to other parties, knowingly or unknowingly.

Given the falsity of this assumption about the power of self-interest to self-regulate, bankers have a responsibility to assess the contribution that their bank is making to systemic risk that affects the whole of society and not merely their own shareholders.  Put starkly, we should be able to trust bankers not to destroy the whole economy.  

Third, financialization or the portfolio society creates a responsibility on the part of the financial services sector to provide products and services that truly fit people’s needs. Much financial innovation seems to be more focused on what makes profit for the banks’ shareholders than on the good of the people whom banks claim to be serving.

He quoted from Paul Volker, a respected former Federal Reserve Board chairman, who opined that ‘the only useful recent financial innovation was the ATM machine’.  John emphasised his argument by also citing New York Times columnist and Princeton economics professor Paul Krugman suggesting it is “hard to think of any major recent financial innovation that actually aided society, as opposed to being new, improved ways to blow bubbles, evade regulation and implement de facto Ponzi schemes.”

If we now must trust bankers more to provide the products and services that are essential to our welfare and security, then they must earn that trust by taking greater responsibility for the implications of financialization or the portfolio society.

He summarized and concluded with three key points. First, since banking cannot be conducted solely by bilateral market contracting but serves an intermediation function between multiple parties, trust and integrity are requirements.

Second, the utility character of banking also creates a need for trust due to the dependence of the economy on banking services.  However, despite the need for trust and integrity in banking, he also cautioned against placing too much reliance on morality or ethics as a means of ensuring the proper functioning of the banking system.  In order to avoid the problem of moralization, we need to find a workable balance between market forces, government regulation, institutional design, and morality as means for controlling banking activity.

Finally, he said he attempted to describe some of the implications for trust and integrity from the changed nature of banking.  Modern banking, as opposed to the traditional form, has been transformed by the division of the “value chain,” the new “business as usual,” and financialization or the emergence of the “portfolio society.”  Each of these changes alters and expands the responsibilities of bankers in significant ways.

John’s final comments were that a suspicion of banking has existed from the time of the founding of the United States and resentment over periodic banking crises continues to undermine trust.  Many critics of modern banking warn that crises will continue unless drastic action is taken, especially with regard to the banks that are “too big to fail.”

He explained that opinion differs on what to do.  Some, such as Joseph Stiglitz, argue that the big banks should be broken up and their activities restricted. Others, such as Mervyn King, recommend separating utility and casino banking, a view echoed by the advocates of limited purpose banking, which is essentially a return to the banks depicted in “It’s a Wonderful Life.”  Ultimately the typical reaction though has been to simply to impose more stringent regulation—2300 pages of it!

Fortunately at an event titled ‘Does Integrity Matter’ John concluded that, whatever the outcome of the ‘what to do’ debate, it was evident that the challenge of restoring trust and integrity in banking is as difficult as it is necessary.

Integrity in the Financial Services Industry: How to Use Epistemic Virtues

Boudewijn de Bruin is professor of financial ethics, a new chair in the Faculty of Economics and Business of the University of Groningen, The Netherlands. With a background in mathematics and philosophy from Amsterdam, Berkeley and Harvard and a PhD on the epistemic programme in game theory, Boudewijn was well suited to discuss the financial literacy of citizens and mis-selling of financial products.

He opened by suggesting (i) sales and marketing techniques lead a considerable number of consumers to buy financial services from which they will not benefit. Among other things, this is due to the fact that consumers do not understand the products. He used the examples of interest-only mortgages (ABN AMRO) and retirement plans.

(ii) Ignorance is only partly remedied by financial literacy programmes (Lusardi, 2010). 20% of the Dutch don’t know how compound interest works and 35 don’t know the difference between stocks and bonds (Van Rooij, et al. 2010). While financial literacy programmes raise consumers’ knowledge about financial products, these programmes can only be part of the solution. Many products require more knowledge to understand than these programmes offer.

(iii) Banning complex financial products not an option (Shiller, 2009) Where do you draw the line? A continuous workout mortgage … savings account?  The British government and many others have suggested that it is no solution to prohibit the selling of complex financial products to individuals who do not understand them, as this would unjustifiably exclude them from obtaining many highly useful products.

Financial literacy programmes traditionally focus on providing individuals with basic concepts of finance such as compound interest and the difference between real and nominal value. While this is important, the knowledge of many consumers will remain insufficient to understand more complex issues.

Boudewijn said behavioural finance shows that people are prone to biases that make them deal inadequately with situations in which they lack knowledge. The confirmation bias makes consumers reject alternative options too easily and on the basis of insufficient information, while unrealistic optimism makes them underestimate many risks such as unemployment and sickness.

So it’s not only our mere lack of knowledge that causes trouble, but also the way we deal with our lack of knowledge.

The question is: what should be done? Using insights from virtue epistemology (a recent rapprochement between ethics and the theory of knowledge), Boudewijn puts forward the claim that the financial services industry has to contribute to consumers exercising so-called epistemic virtues with episteme meaning knowledge.

Research since the 1990s suggests that empowering people with epistemic virtues involves elements of virtue ethics applied to epistemic or knowledge related issues whereby the people adopt beliefs and gain knowledge.

Epistemic impartiality requires a degree of open-mindedness, a readiness to confront one’s ideas with those of others and an active awareness of one’s fallibility,

Epistemic sobriety requires steering a middle course between a reckless, overly enthusiastic adoption of beliefs and inert disinterestedness, leading to reticence to espouse any beliefs.

Epistemic courage requires subjecting one’s beliefs to scrutiny, persisting in one’s inquiry and the confidence to keep asking questions, even if this reveals ignorance.

The next question is do epistemic virtues actually help? Boudewijn explained that successful applications of virtue epistemology to medical ethics suggest that epistemic virtues such as impartiality, open-mindedness and epistemic courage can empower people and help consumers cope with situations in which they lack sufficient information.

‘Active Searchers’ manage to gain better mortgage deals and retirement plans. But how do we make citizens searchers?

Training in epistemic virtues involves distinguishing between various epistemic states varying from ‘Don’t have a clue’ to ‘Have a vague hunch’ and ‘Absolute certainty’. It also involves distinguishing between various epistemic states and various kinds of evidence from the Tabloids to The Financial Times. It also involves distinguishing between varying strengths of evidence from ‘Some indication’ to ‘Overwhelming proof’ and continually asking questions.

The overarching idea is that training in epistemic virtues is likely to be more successful in interactive settings where participants are confronted with their epistemic vices and virtues and they can see how they progress, such as an interactive training website and role playing games which can assist financial empowerment even for children.

So what can financial services professionals and professional bodies and regulators do?

Boudewijn referred to the example of the UK Financial Services Authority (FSA) Guide to Pensions:

Some types of employer’s schemes (the ones called ‘final salary’ or ‘defined benefit’ scheme) give you a guaranteed pension.

In a final salary scheme you know broadly how much pension you’ll get, while the amount of pension you get from a personal pension is unpredictable.

The situation then arose whereby 60,000 to 120,000 British citizens lost all or part of their pensions because employers became insolvent. Some argued that they had opted for a ‘guaranteed’ occupational pension. The FSA retorted: ‘We never said that guaranteed means guaranteed in all circumstances’.

Boudewijn  said it is true that ‘guarantee’ typically means something quite absolute, but the  FSA’s aim was to explain difference between defined-benefit (guaranteed) and defined-contribution (unpredictable) pensions. The FSA falsely believed that citizens would have known that ‘guaranteed’ means ‘conditionally guaranteed’. On the other hand citizens falsely believed that the FSA meant ‘unconditionally guaranteed’.

Boudewijn  suggested if a person is unaware of the difference between Defined Benefit and Defined Contribution and needs the FSA guide to learn about it, he or she will very likely be unaware of insolvency risks as well and hence will be likely to interpret ‘guarantee’ as something quite absolute.

In this situation the citizen lacks the knowledge even to become suspicious, whilst the FSA has the knowledge to predict citizens may misinterpret the guides. He recommended that the FSA should exercise the epistemic virtue of intertranspicuity. ultimately meaning making it easier for readers to easily construe or comprehend advice in an interconnected manner between issues.

Boudewijn said everyone benefitted from epistemic virtues but financial literacy is likely to remain low in a significant portion of the population. He stressed the responsibility shouldn’t be left only to citizens and clients.

In this regard he suggested there were two further areas in which professionals needed to evolve. The first concerned the financial services industry as a whole. In cooperation with state agencies the industry should contribute to the development of financial literacy programmes that provide citizens not only with financial knowledge, but also with epistemic virtues that help them cope with situations in which they lack knowledge. When practitioners and government provide information, they need to better adopt the perspective of their audience. Client interests need to become more central and this may require a change of perspective, possibly incorporating a course on ‘Financial Ethics’.

The second claim concerns the integrity of finance practitioners who ought to avoid interfering with consumers exercising epistemic virtues. This amounts to more than avoiding deceptive sales and marketing techniques. Practitioners need to provide appropriate and adequate information tailored to the specific level of knowledge of their specific clients.

Using recent work on intersubjective and other-regarding epistemic virtues, Boudewijn argued that their professional integrity also required that they actively track whether clients process the information adequately, and whether they use it in an appropriate manner.

Financial Industry Integrity and the Separation of Law and Morals (or Why Financial Industry Integrity Matters)


Steven McNamara has an unusual background. He practiced corporate and tax law in New York City for five years, working on capital markets, financial instruments and merger & acquisition transactions. Prior to this with a Ph.D in Philosophy he taught that subject at Boston College and Al Akhawayn University in Ifrane, Morocco, before earning his law degree at Columbia. Having survived his foray into the corporate world with his sanity intact, he reverted to academia and now teaches ethics and business law at the Olayan School of Business at the American University of Beirut.

Steve is perhaps uniquely qualified to discuss integrity in the context of financial institution business practices that precipitated the credit crisis and “Great Recession.” Because the real estate bubble was enabled by excessive lending, much of it occurring through the largely unregulated shadow-banking system, it resulted in a wholesale threat to the American and even global financial systems. Thus, the question of whether integrity matters on the part of financial executives has widespread importance for our societies.

He suggested that the ultimate significance of financial industry integrity is political, because market capitalism intrinsically relies on governmental support through the legal and regulatory systems which societies construct and pay for.

If the public turns decisively against the banking industry, perhaps due to a perception of low integrity in its business conduct, that industry will not continue to exist, at least in anything like its current form. Consider the consequences for the financial industry had the U.S. Congress not approved the troubled asset relief (TARP) and term asset-backed-securities loan facility (TALF) programs in the immediate aftermath of the crisis of September 2008.

Steve displayed extraordinary knowledge of financial markets and initially related three instances of the loss of business integrity:

  • the subtle ways in which external considerations came to influence structured finance credit ratings at Moody’s, Standard & Poor’s and Fitch;
  • Goldman Sachs’s ABACUS 2007-AC1 transaction, which allowed hedge fund giant John Paulson to short the US housing market at the expense of investors in the transaction; and
  • Citibank CEO Charles Prince’s famous statement in July 2007 that “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. And we’re still dancing.”

He then discussed just what integrity is and how it manifests itself in the business context. Drawing on Yale Law School professor Stephen Carter’s discussion of integrity, he defined integrity as “action guided by an individual’s moral beliefs when something important is at stake.”

Steve then discussed the requirements of law and those of morality, and why a free society does not attempt to mandate acting with integrity through law but instead leaves this to the judgment of the individual.

He concluded with two key consequences of this: first, extreme or corrupt business conditions can lead to a situation in which ethical business leaders are forced to withdraw from business competition or risk the loss of their integrity. Second, just as the ultimate ramifications of acting with or without integrity are political, political leaders and regulators face the ultimate responsibility for creating an environment within which ethical business practice succeeds.

Steve said with the benefit of hindsight it was clear that governmental leaders in the US failed to act with integrity as ultimate stewards of a market economy, largely through the naive acceptance of the belief that a market economy in fact does not require regulation. For a market economy to succeed in a sustainable fashion, Steve suggested business leaders must act with a modicum or more of integrity, supported by government regulations that police business people who would engage in abusive business practices.

Micro Finance Crisis in India

Prof Uma Narain, from the S.P. Jain Institute of Management & Research, Bombay, India, spoke about the provision of Microfinance in India. Uma was one of the most regular providers of advice both at the previous years event at Tampere, Finland, and during the intervening year for which we are most grateful. Like many of the other visitors, she and her husband managed the task of driving around Ireland in a matter of three or four days prior to the event which to most Irish would seem impossible but to someone from a country the size of India must have seemed like an afternoon stroll!

As well as our gratitude we do also owe her an apology. She had requested some element of Irish literature be incorporated in the event so we invited a well known Senator in the Irish parliament to give a talk on James Joyce, Samuel Beckett, Oscar Wilde et al. Unfortunately, having decided to run in the Irish Presidential Election, he pulled out of the event – too busy on the campaign trail – so Riverdance and Irish music had to suffice.

Uma was also the first speaker at the conference to visibly suggest by powerpoint: Of course integrity matters !!! Her preferred definition of Integrity was from the Stanford Encyclopedia of Philosophy:

Integrity is taken primarily as a formal relation one has to oneself, connected in an important way to acting morally (putting into practice). There are some substantive or normative constraints on what it is to act with integrity.

She introduced her talk by suggesting that if we ‘hijack’ integrity from the most noble idea or initiative, it could turn exploitative like Shylock, as some examples of microfinance reveal.

According to CGAP, a branch of the World Bank dedicated towards promoting micro-credit, the Mission of Microfinance included Eradication of poverty & hunger, Universal primary education, Gender equality & empowerment, Reduction in child mortality and Improvement of Maternal health. Uma set the scene by referring to The Millennium Development Goals 2000 which set critical global priorities, notably halving the number of people in extreme poverty.

Uma noted the century began with two popular concepts focused on the poor:

  1. Management thinker C K. Prahlad surprised everyone by drawing attention to the ultra poor populace as a possible source of ‘financial returns’ by fathoming the ‘fortune at the bottom of the pyramid’ as a ‘for profit’ venture.
  2. A sudden surge in Micro Finance Institutions (MFI) offering ‘tiny amounts of money to the people with tinier assets’ in a bid to eliminate poverty and promote inclusive growth – the immediate inspiration being Nobel laureate Mohammed Yunus, of Grameen Bank, Bangladesh who was leading a ‘not-for-profit’ social movement by creating ‘social returns’ among the same ‘bottom of the pyramid’ ultra poor through microfinance.

After introducing microfinance using some complex tables and graphs she said she believed MFIs attracted two types of players: ‘for profit’ & ‘not for profit’ – those seeking financial returns for themselves and/or creating social benefit for the poor.

By the end of 2009, the MFI sector had exceeded 91 million customers, mostly women, with loans totaling more than $70 billion. India and Bangladesh, home to the world’s fastest growing microcredit business, accounted for half of all borrowers.

However early in 2011 the good news story of microfinance turned nasty when it was revealed that in the state of Andhra Pradesh, where about a third of the country’s $5.3 billion microfinance loans are disbursed, about 70 people committed suicide over a period of nine months to escape payments or to end the agony their debt had triggered.

While some lending firms were growing at 60 to 100% a year and accruing profits that could shock a Wall Street banker, these people were trapped in the quagmire of life threatening multiple-borrowing-cycles.

It just did not add up. Had a Shylock returned? she queried.

Uma mentioned Kafan (Shroud) by Munshi Prem Chand whereby a poor man collects money for the funeral rites of his dead wife, but spends it on food and drink. She suggested the story expresses the problems of the rural peasant classes, their truths and experiences of life resulting in existentialist choices (Jean Paul Sartre) which are not always rational.

She then quoted Shylock from Shakespeare’s Merchant of Venice which exemplifies and abhors profiteering out of people’s grief & helplessness. “Neither a borrower nor a lender be,…borrowing dulls the edge of husbandry”

She also drew attention to the fact that usury is still prohibited in many cultures. ‘Pay readily the Zakat (poor due) on your property’ for inclusive growth –  from the last sermon of the Holy Prophet of Islam.

Uma then detailed the case of SKS Microfinance which was founded in 1998 and ultimately floated an IPO during 2010 which was 14 times oversubscribed and sold shares 95 times higher than what they had paid.

Founded by former McKinsey consultant, Vikram Akula, in 1998 as a ‘not for profit’ NGO, SKS promoters used poor women to morph to ‘for-profit’ NBFC in 2005. In 2006 Time magazine named Akula  as one of world’s 100 most influential people. He was arrested in 2010 following previous Q4 2009 losses and admitted lapses including diversification into secured loans, gold loans, mobile handsets & grocery stores. The share price fell dramatically.

The state government halted all collections and lending. The governor of the central bank called MFIs “India’s subprime” – leveraged money lending. A high power panel, under the chairmanship of Mr. Malegam was set up to report on the MFI saga. The report recommended borrowing limits and a cap on interest of 24%.

Uma noted the lessons from the SKS debacle included profit margins were too high, a loan life-cycle of around 6 months was too short to allow money to be used for productive purposes, often only the vulnerable poor women are chosen as customers and easy access to money and multiple loans may make some people lethargic.

Microfinance could produce a debt trap, not empowerment, as women borrowed, their men decided whether to spend or squander, yet recovery agents pressurized the women and in cases of default, the men often escaped to work during the day when the collection agents arrived.

Uma explained how overproduction of local produce could gut the local market for which there could be no local buyers.

Poverty is multifaceted, complex  & protean. Its alleviation requires interventions at various levels. Microfinance is one of them but it is a far too limited tool. The World Bank, Harvard Institute and famous industrialists noted how MF became detrimental to poverty eradication and pushed the poor further into a debt trap. Only MFI grew. The free market profit model was never likely to deliver.

Her presentation included photographs of children orphaned after both their parents committed suicide to escape their debt. The region of Andhra Pradesh, where three-quarters of the 76 million people live in rural areas, suffered a total of 14,364 suicide cases in the first nine months of 2010.

Uma noted how MF firms with the right values have done well but those who were not quite alright have also done well in the short run. She suggested values needed to sink into the rank and file but is a very slow process. Businesses with poorer values did not die so easily and often went unnoticed until a catastrophe struck.

As MFIs turn towards commercialization, Uma said credit schemes for the ultra poor in developing nations need to be examined bearing in mind the anthropological, informational and aptitude constraints of the local populace. The serious questions which need addressing include: How much are the poor really helped by microfinance?  Is inclusive growth – a myth? Just as there are well established parameters to ascertain the financial health of an MFI, can there be proxy indicators to gauge the social performance reporting in microcredit? Loan repayment cannot be a measure of social good. What are the consequences of making credit available to all the poor? Is employment opportunity a better option? Should Microfinance be the first product for the poor? Is Cash credit a drug in the hands of poor?

She stressed the role of a strong regulatory body and wondered whether a commercial bank could do the job of MF provision better – or at all?

She suggested financial products with social service delivery should be considered as the double bottom line’ model in Microfinance.

Uma concluded by saying that a sense of service was paramount and that the free market ‘for profit’ model had serious limitations. Integrity, using her description of acting morally and putting beliefs into practice should be used as a lens to see how effectively MFIs translate their mission into practice.


Law, Integrity, Credit Managers & Trade Overpayments

Maurice O’Brien is an Irish based Credit Manager of a large multi national, a graduate member of the Irish and UK and Institutes of Credit Management with over twenty five years experience in trade credit. He is presently working with the Irish Institute to produce a Code of Practice for the Treatment of Trade overpayments.

Maurice’s presentation opened by observing that overpayment of trade accounts is a frequent occurrence and posing the question What would be your reaction if your overpayment was quietly retained? He gave examples of instances and defined precisely what made up a trade overpayment.

He cited the UK Pertemps Recruitment Ltd v. HMRC case whereby the common law does establish an entitlement to a refund of monies paid by mistake under the principle of unjust enrichment for monies had and received; however it is up to the party who made the payment to initiate a claim:

 “As the overpayments were made…..under a mistake, the customer has a claim in restitution…The claim arises because (the appellant) has been unjustly enriched as a consequence of the payment. The customer’s claim arises under the common law ….for money “had and received”. (No.22)

 “Although a customer may have a restitutionary claim against (the appellant) a common law claim in restitution does not automatically give rise to a debt in favour of the customer. Like many other common law claims, a debt does not arise unless a court gives judgement in favour of the customer for a specific amount”. (No.23)

Given the vacuum created by such uncertain governance there is enormous variety in the policies found regarding the treatment of overpayments. These range from commendable diligence to taking grossly unfair advantage of such situations.

He quoted from Auditing Practices Board Practice Note 12 issued September 2010 which makes reference to retention of overpayments found in the course of an Audit.

“The auditor considers whether the retention of the overpayments might amount to theft by the audit client from the customer…If so, the client will be in possession of the proceeds of its crimes, a money laundering offence.”

Maurice discussed a number of other remedies and quoted from Irish Institute of Credit Management introduces Guidance Notes for the treatment of trade overpayments. “The purpose of these Guidance Notes is to provide clear guidelines to credit professionals and to the business community for dealing with various types of customer overpayments. It acknowledges the need for a uniform system of practice that protects the rights of parties who make overpayments while promoting reciprocal arrangements which will benefit all who apply the guidelines.”

The Key Principles of the IICM Guidance Notes state:

You should not…

  • Take any action which results in the concealment of overpayments from the payer or from any other party entitled to the information.
  • Treat overpayments as unearned profits of the trade or business.
  • Use the proceeds of overpayments to offset losses of the trade or business.

You should…

  • Notify the overpaying party.
  • Make a genuine effort to agree disposal of overpaid sums with the payer either by means of refund or by netting against other liabilities.
  • Keep a record which allows overpayments to be easily identified in the books of your business.
  • Incorporate your overpayments policy in your Terms and Conditions of Trade

Maurice also discussed the role of integrity. He said it was impossible but to label as dishonest an approach which in the first place conceals overpayments from the party who paid in error and then removes the potential liability to repayment from their books by a unilateral reclassification of the receipt as an unearned profit.

To act with integrity in regard to trade overpayments would require a set of actions considerably more pro active than waiting for a refund request or even worse waiting until a court upholds a claim in restitution.

It requires positive engagement with the overpaying party to reconcile and mutually agree a disposal and it requires putting a process in place with regular customers to cater for periodic review of overpayments and credits. Doing so on a reciprocal basis strengthens the business relationship and raises it to a new level of trust.


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