Another week, another banking scandal. In the past few years we have seen what appears to be an endless line-up of banks behaving badly. They have engaged in rate manipulation, rogue trading, product mis-selling and some have even died – leaving the taxpayer to pick up the bill.
Last week, it was JPMorgan’s turn on the naughty step. The elite North American investment bank has faced a raft of allegations including nepotistic employment practices in China, miscategorising investments in a wealthy client’s portfolio, selling questionable mortgage backed securities to US government agencies and manipulating the US energy market.
Such claims could cost JPMorgan dearly. At the start of the week, a New York judge requested the bank to pay $42.3m plus interest to a Russian billionaire. This is small change when compared to the $6 billion that the US Federal housing agency are demanding the bank pays to settle allegations it mis-sold mortgage backed securities in the run-up to the financial crisis. When put together, all these legal headaches are a significant cost.
The mounting legal fees could be seen as an annoying cost of doing business. But the real price of all these legal challenges and the associated media furor that comes with them are to the legitimacy of the bank. A loss of legitimacy for a business can have significant consequences: higher capital costs, demotivated employees, increased regulations, negative media attention and wary customers.
If declining legitimacy is a real problem for the large banks, then how can they try to win it back? Window dressing is always a huge temptation, but the big problem is that saying you have changed is often quite different from actually making the change. There are many cases where businesses announce a big change that is supposed to make them more responsible. They get the glory, but they don’t do the follow through.
For instance, some pharmaceutical firms which were under pressure from activists to provide cheap HIV medication in developing countries announced they were going to drop their prices, but did not do anything for quite some time. This is a kind of organised hypocrisy whereby organisations maintain a distance between what they say and what this do. Hypocrisy has the advantage of helping an organisation comply with the demands of external stakeholders at the same time as the core operational processes are left untouched.
Window dressing is certainly one tactic a bank might pursue. They could publicly admit they were wrong, say “things are going to change around here”, and announce a few high-profile programmes designed to clean up operations.
But at the same time, it is also possible to “de-couple” these changes from the everyday working practices and routines in the bank. This means that the banks will not have to engage in the difficult, costly and often painful process of changing the work routines. This would be tantamount to reminding bankers that appearing to be good is important, but it should not be taken too seriously.
Although window dressing is very tempting, recent research has suggested it can also be dangerous. A study of an unnamed US financial organisation following a scandal triggered by deceptive sales practices show how these dangers work.
When faced with a scandal, the organisation initially developed a façade that looked good from the outside, but was detached from the day-to-day sales practices within the firm. This created a rift between what external stakeholders thought the firm was doing and what people within the firm were actually doing. People within the firm felt like pressure was off and went on with their old ways, and mis-selling became even more widespread.
Gradually this came to the attention of regulators and others. It destroyed the fragile sense of legitimacy the firm had been able to rebuild following the scandal, and it once again became a pariah in its industry. The lesson here is that window dressing might help a firm rebuild legitimacy in the short term, but it creates the conditions for unethical practices to thrive beneath the surface, which will undermine the legitimacy of the firm in the longer term.
What’s a bank to do?
This has some important implications for large banks like JPMorgan. They may be tempted to take a financial hit on the legal cases, say they were wrong in public, and then do some ethical window dressing. But this may simply create the conditions for unethical practices to thrive behind the nice façade, leading to yet more scandals.
If the bank hopes to rebuild its legitimacy over the longer term, it needs to ensure there is a tighter connection between their public pronouncements and the practices behind the scenes. Doing this does not just involve restructuring, a new set of values or a few training courses. It involves deeper changes to the day-to-day routines, business practices and culture.
There are some constructive steps which large banks can take. The first is that when new compliance or ethics programmes are introduced into a firm, it is vital to highlight these are not being done for cynical reasons (such as avoiding legal issues).
Second, it is important that the values a firm connects with its compliance and risk management activities resonate with the personal and professional values of people within the firm. Many people working in knowledge intensive organisations like banks feel their work is utterly disconnected from their values outside the workplace. Organisational pressures have often clashed with professional commitments and there is a real opportunities to recreate some alignment here.
Finally, new measures designed to get rid of unethical activities must be built into the everyday work processes in an organisation. The large banks have already taken some steps in this direction. But it is really a matter of ensuring that this becomes part of the core work processes, not just pesky internal policing which holds back deal-making.
Winning back public trust in the banking sector will not be an easy task, but it is a vital challenge both for JPMorgan and across the whole sector. If attempts to change really are revealed as mere “window dressing”, the next time a big scandal hits the public are likely to be far less understanding.