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Restoring trust in financial services: governance, norms and behaviour

Crean, A., Gold, N., Vines, D., Williamson, A.

How can trustworthy behaviour amongst financial firms be supported by governance and by the internal relationships within such firms? We argue that norms, or patterns of behaviour, need to change to ensure a trustworthy outcome for the industry as a whole.

Trustworthiness requires reliable competence and honesty. Lack of trustworthiness in finance can be attributed to short termism, occurring both because self-interested boards of firms pursue short-term maximisation of shareholder value and because employees also act in a self-interested manner. Neither of these behaviours take true account of the longer-term interests of investors or savers. Pursuit of reputation by self-interested firms, combined with the effects of regulation, is unlikely to circumvent these problems in anything other than a fragile manner.

In our paper we ask what could be done to make such financial firms more trustworthy. We consider a range of actors within the firms:  shareholders, the board, mortgage lenders, fund managers, insurers, traders, and middle-managers. We show in detail how, for all of the activities other than trading, a concern for the wellbeing of clients might sustain more trustworthy patterns of behaviour, i.e. more trustworthy norms, in circumstances when self- interested behaviour will not do this. Going beyond this, there is a widespread understanding that patterns of behaviour are often copied. As a result, the behaviour of those with a concern for others might influence the behaviour of self-interested actors. It might be that trustworthy behaviour becomes the norm.

A policy of financial reform might therefore attempt to change motivations. Alternatively, such a policy might set out standards of trustworthy behavior. In addition, it might be possible to directly intervene to bring about changes in the work practices of at least some people, in a manner that is informed by psychology and behavioural economics, in order to cause these people to act in a more trustworthy manner. Such trustworthy behaviour might spread and become the norm. Ensuring a change in norms appears to be an essential part of the required change of culture in finance.

But trading activity is different. Trading does not need to be – and cannot be – supported by actors whose motivations relate to the wellbeing of clients. Trading is a self-interested activity, it is not concerned with achieving ‘fair’ outcomes. What matters is the avoidance of fraud.

This difference matters. Actors providing the other services in finance might come to copy traders, and regard the wellbeing of clients as unimportant. Then it may not be possible to sustain trustworthy standards, or behaviour in the provision of these services. There is some evidence that this has happened.

Our work identifies two key challenges for the governance of financial firms. First, there is a need to prevent the self-interested motivations of traders from infecting the motivations of those in other parts of the institution. Second, even if this contamination of motivations does not happen, there is a risk that activities of traders in a firm can damage the wellbeing of the clients in other parts of the firm. It may be, for example, that these clients hold assets the price of which the traders in the firm are seeking to depress. There may thus actually be a need for a board to protect the customers in the client-facing parts of the firm from the effects of the activities of its traders.

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