Kent Academic Repository Full text document (pdf) Citation for published version Colley, Graham (2017) Taming the Tiger: solving the problems of banks. Why regulation and reforming ethics do not work and why there will be another banking crisis. Master of Law by Research (LLMRes) thesis, University of Kent,. DOI Link to record in KAR https://kar.kent.ac.uk/68540/ Document Version UNSPECIFIED Copyright & reuse Content in the Kent Academic Repository is made available for research purposes. Unless otherwise stated all content is protected by copyright and in the absence of an open licence (eg Creative Commons), permissions for further reuse of content should be sought from the publisher, author or other copyright holder. Versions of research The version in the Kent Academic Repository may differ from the final published version. Users are advised to check http://kar.kent.ac.uk for the status of the paper. Users should always cite the published version of record. Enquiries For any further enquiries regarding the licence status of this document, please contact: [email protected] If you believe this document infringes copyright then please contact the KAR admin team with the take-down information provided at http://kar.kent.ac.uk/contact.html Taming the Tiger: solving the problems of banks Why regulation and reforming ethics do not work and why there will be another banking crisis Graham David Colley A Dissertation Submitted for the Degree of Master of Law Kent Law School, The University of Kent - Kent December 2017 Abstract Tigers, like banks, are kings in their jungle. Both survive because of their strength and both cause public fear when they ‘run amok’. Mankind has always wished that it could tame tigers - and banks. Whilst banks are essential to an economy, this dissertation considers the desire to control the difficulties banks cause. Using examples, it looks at the problems to which banks and bankers are prone. The traditional problem is of ‘borrowing short and lending long’, but the examples show other problems that have arisen, including those that led to the Financial Crisis 2007-2008. It is suggested that one cause of the problems of banks is of ‘Financialisation’ and, in particular, the demands of shareholders for ‘Return on Equity’. The dissertation considers two ways used to control banks. Firstly, it looks at regulation, with reference to the example of capital regulation. It outlines how equity capital appears on a bank’s balance sheet, reviews the problems of capital regulation and concludes that bankers seek to circumvent or change regulations that hinder the aim to maximise profit. Secondly, having discussed the limits of regulation, it considers the alternative of changing organisational culture to improve the conduct of bankers. The dissertation looks at different approaches to such cultural change, but concludes that the pressures to produce Return on Equity prevail over exhortations to act ethically. The dissertation then considers whether shareholder control could ameliorate the problematic conduct of bankers and concludes that shareholders exacerbate the problem. Finally, the dissertation introduces the possible use of alternative legal structures, which are not subject to demands to provide Return on Equity. The dissertation suggests that such alternative legal structures present an area for future research. 1 Contents Abstract Acknowledgements Table of Abbreviations 1. Chapter 1 - Introduction ................................................................................................. 8 1.1 The Importance of Banks................................................................................................. 9 1.2 Inherent Problems of Banking ....................................................................................... 12 1.2.1 Borrowing short and lending long – a fundamental problem................................... 12 1.2.2 The Financial Crisis 2007-2008: the banking problem that affected the world...... 13 1.2.3 Some Examples of Scandals that have affected Banks ............................................ 16 1.2.4 How the press and public react to the problems of banks and how it makes matters worse. .................................................................................................................................... 19 1.3 Financialisation and Return on Equity (“RoE”) ........................................................... 23 1.3.1 Return on Equity (“RoE”) .......................................................................................... 24 1.3.2 The Growth of Credit.................................................................................................. 25 1.3.3 Growth in Financial Products ..................................................................................... 26 1.3.4 The effect of Financialisation on Banks .................................................................... 27 1.4 Research Potential, Methodology and Outline of Chapters ........................................ 29 2. Chapter 2 - The Limitations of Banking Regulation ................................................ 32 2.1 Introduction - The Objectives of Regulation ................................................................ 32 2.2 Equity capital in the bank’s balance sheet. ................................................................... 34 2.3 Capital requirements ...................................................................................................... 37 2.3.1 Risk-Weighted Assets ................................................................................................. 42 2.4 Critical Assessment of Capital Requirements and Basel III........................................ 43 2.4.1 Problems with Risk-Weighted Assets ....................................................................... 46 2.4.2 Manipulation of Impairment Provision ..................................................................... 48 2.4.3 The problem of capital adequacy promoting procyclicality ..................................... 48 2.4.4 Off Balance Sheet Entities.......................................................................................... 50 2.4.5 Reliance on Credit Rating Agencies .......................................................................... 51 2.4.6 Problems Caused by the Credit Creation Theory of Banking .................................. 51 2.5 Would abolition of reliance on bank deposits overcome the question of capital adequacy? .............................................................................................................................. 52 2.6 Conclusions – Regulation has limits ............................................................................. 54 3. Chapter 3 “Why cultural change is not enough” ...................................................... 56 3.1 Introduction .................................................................................................................... 56 3.2 Culture: How Changes in the Business Model of Banking have Sought to Change the Ethics of Banking. ................................................................................................................ 57 2 3.3 Unethical Behaviour ...................................................................................................... 60 3.4 The Limits of the Regulatory Standards ....................................................................... 64 3.5 Changes in corporate culture as an alternative approach to the problems of banks .. 66 3.6 Explanations for the Ethical/Moral Problems in Banking ........................................... 67 3.7 The Introduction of Ethics and Morality as a way of dealing with the Problems of Banks ..................................................................................................................................... 67 3.7.1 Too-Big-to-Fail (“TBTF”).......................................................................................... 70 3.7.2 A Culture of Insecurity ............................................................................................... 72 3.7.3 Bankers’ Bonuses - the Remuneration Problem ....................................................... 73 3.7.4 The Individual Psychology of a Banker .................................................................... 74 3.8 Cognitive Moral Development and Ethical Decision-Making (“EDM”) ................... 76 3.9 The Importance of Leadership....................................................................................... 78 3.10 The Role of Organisational Culture in Ethical Decision-Making ............................. 79 3.12 Conclusions: Returning to the Limits Regulation ...................................................... 83 4. Chapter 4: Conclusions and proposals for future Research ....................................... 85 4.1 Banking - the continuing problem................................................................................. 85 4.2 Suggestions for reform ................................................................................................... 87 4.3 Why not rely on shareholder control? ........................................................................... 89 4.4 Could banks with alternative legal structures help? Opportunities for future research ............................................................................................................................................... 91 Bibliography 3 Acknowledgements My journey