Banking on ethics Challenges and opportunities for the European ethical banking industry in the aftermath of the financial crisis Banking on ethics Summary Author: Valerio Carboni Editing: Andrea Baranes, Antonio Tricarico Executive Summary p. 2 Graphic design: Carlo Dojmi di Delupis Introduction p. 4 CRBM - Campagna per la Riforma della Banca 1. Industry overview p. 6 Mondiale Via Tommaso da Celano 15 1.1. Industry characteristics Roma (Italy) tel. +39.06.7826855 Fax. +39.06.7858100 2. The impact of the financial crisis on ethical banking p. 11 web: www.crbm.org email: [email protected] 2.1. The cost of the financial crisis 2.2. Ethical banks’ performance in a challenging environment This publication has been 2.3. Basel III Accord on capital requirements produced with the kind support 2.4. Which challenges from Basel III for the ethical banking industry? of the Ford Foundation and the Charles Stewart Mott Foundation. 3. Ethical banking with social goals p. 16 March, 2011 3.1. The French new economic regulation 3.2. The UK community banking experience 4. Ethical banking with environmental goals p. 26 4.1. The Dutch Green Fund scheme 4.2. Green Fund scheme overview 4.3. The case of Banca Etica in Italy 5. Conclusions p. 33 Bibliography p.36 Banking on ethics 1 Executive summary The 2008 global financial meltdown model of society where social and environmental variables are taken into account by investors’ and savers’ decisions. has clearly revealed to which extent The European ethical banking industry is a multifaceted financial institutions operating in a free, landscape characterized by a wide range of actors and unregulated and self interest mode can practices. This research identifies key experiences of ethi- cal banking in Europe in order to highlight the different fail to protect themselves, the depositors business models emerged, particularly in reference to the and the community. While we are still type of institutions involved and the objectives pursued. This approach provides a reliable framework to the study far from reaching a conclusion on what of the public policies adopted by governments to support are the best solutions to fix the financial this industry, and to understand to which extent they system, there is a broad consensus have been successful. Excluding the public entities and the mainstream banks that enforce some CSR policy, but pointing to the fact that shareholders’ are still far away from a coherent approach to sustain- expectations for ever-increasing returns able finance, some seventy institutions matching a strict definition of ethical banking and operating around a progressively pushed financial institutions common set of principles and values have been identified to shy away from traditional banking in Europe. activities in favour of increasingly These actors can be firstly divided into banking and non- complex, risky and highly profitable banking companies, and further present different busi- strategies that ultimately led to the ness models, corporate structure, mission and financial strategy. While some of these differences are linked to financial crisis. cultural or historical reasons, others depend on the way national policies and legislations are shaped and helped While rebuilding honesty and trust in financial practices or slowed down the development of ethical finance. is a critical first step towards a more healthy industry, in In this sense, some key legislations helped the develop- order to be ultimately successful, the financial reforms ment of particular sectors of sustainable finance. The should not lose sight of the critical role that banks play in cases of the French social economy, the UK CITR scheme, the communities in which they operate. Financial institu- the Dutch green fund scheme led to good results, both tions do not operate just like ordinary companies but in terms of economical goals and specalized financial carry specific responsibilities towards the community; in intermediaries growth. Other ethical financial companies a way, banks operate more like public utilities providing headed towards microcredit, while several focus their basic services to the public at large. intervention on financial exclusion and access to credit. Some experiences, such as the Italian one, proves that In other words, the way we save and invest, and how a bottom–up development of ethical finance is possible banks allocate capital between alternative uses, brings even without specific legislative frameworks, but evidence critical economic and social conse- shows that the regulatory environ- quences that cannot just be ignored Financial institutions do not ment plays a critical role in shap- in favour of short-term profit goals. operate just like ordinary ing this industry and promoting its Inarguably, ethics still matters in fi- companies but carry specific growth. nancial transactions, and not surpris- responsibilities towards the ingly advocates of ethical banking community The policy measures discussed in this are getting increasing attention from work aim generally at increasing the policy makers. supply of funds into the social or green economy through accredited financial institutions: Sustainable and ethical banking has been developing for their scope is to leverage the expertise of the private decades and is becoming a significant force in the finan- financial sector to promote or unlock social or environ- cial industry. Unconventional banks focused on financing mental progress. These measures range from voluntary environmental projects and promoting social entrepre- informational devices to binding legislations. neurship and community businesses have also proved to be particularly resilient to the financial crisis and may well Other important policy initiatives may include tax incen- show a viable alternative to mainstream industry. tives and other policies looking at stimulating the demand Ethical finance is a broad concept that reflect a different for ethical savings which provide savers and investors with 2 Banking on ethics an extra-incentive to invest into the green or the social disadvantage comparing with conventional banking. economy through accredited institutions. They prove Changing the rules is just one side of the coin. The cur- that financial institutions can effectively participate to the rent crisis is first of all a confidence crisis that in order to achievement of national objectives of economic policy be repaired requires a long lasting behavioural change if they can operate within a well-defined framework of as much as a regulatory one. In other words, it is a incentives and objectives. In order to be effective such change of mentality and behaviour that we are looking policies need to set precise and measurable standards and for and not just a change of rules. Ethical banking pave objectives in relation to the criteria the way in this direction and show that banks need to satisfy in order to The time has come to get the that economic profit should not be participate to such schemes and the considered an end in itself but rather voice of this sector strongly qualities or characteristics that the a mean for enterprises to pursue beneficiaries need to satisfy in order heard by decision-makers and their mission. In order to earn back to access to such preferential funding supported by organised civil citizens’ trust, banks and financial channels. society struggling for a strict institutions are expected to engage regulation of the financial in a drastic behavioural change and While these examples provide some industry start looking again and seriously at European best practices, more broad- people’s real needs. At least this is ly it is questionable whether having civil society’s legitimate expectation. a specific regulation for ethical banking would really help in the long-run, or would instead relegate by law this sub- The ethical banking industry has so far kept a relatively sector in a niche while not impacting at all on the remain- low political profile, apart from few exemptions. However ing vast majority of the banking industry. On the contrary, the time has come to get the voice of this sector strongly a European law recognising ethical banking could help to heard by decision-makers and supported by organised civ- define by law the criteria that ring-fence this sub-sector in il society struggling for a strict regulation of the financial order to avoid that in the near future conventional experi- industry. An enormous challenge which requires today ences could set up affiliated ethical banks for green or vision and courage to speak up so that decision-makers whitewashing reasons, with the hope of regaining trust and the public will know that alternatives exist and it is about their integrity in the wider public. up to them to make them more real, relevant and more effective. In short, only keeping practicing in a way which In any case, besides ensuring financial stability and inves- shows clear cut difference from conventional banking will tors’ protection, financial regulations should take into give the ethical banking sector new strengths and oppor- account banks’ special responsibilities and ensure that tunities to produce a long-lasting and deep change in the they are effectively committed to the public good. The whole financial world and society. ethical banking initiatives presented in this work prove that change is indeed possible. Unfortunately, the current regulatory reform initiatives do not seem to make any substantial progress in this direction, and while they cor- rectly address some of the critical flaws of our financial system – from an increase of capital requirements to bet- ter regulation of OTC derivatives and control of systemic risk – they put less emphasis on what should be done to move bankers to change attitude. In some cases, such as the reform of the Basel agreement on banks’ capital adequacy, these needs seem to be ignored. At this point in time it is fair to assume that the Basel 3 agreement on capital adequacy will not include any spe- cific criterion related to environmental and social sustain- ability in risk analyses and management requested to the banks - in particular as concerns capital requirements.