How banks can demonstrate responsible banking during the pandemic

The purpose of banks - to make a profit or be socially useful?

What is the purpose of a bank? Does it have a responsibility to society at large, over and above its duties to its shareholders, customers and employees?

This is a broad question and one which arises in times of crisis and financial instability. In the aftermath of the 2008 financial crisis there was much debate about the social utility of banks, with the then chairman of the Financial Services Authority (FSA), Lord Adair Turner, qualifying some banking activities as “socially useless.” He stated, somewhat prophetically in view of current circumstances, that “not all innovation should be treated in the same category as the innovation of a new pharmaceutical drug (…)”^[1]. Banks and shadow banks were blamed for causing the financial crisis through the creation of “toxic” financial instruments (such as Collateralised Debt Obligations and “CDO Squared”) which were deemed to serve no real economic purpose and created no value for investors; instead they  resulted in market instability and the sub-prime mortgage crisis. It took much effort for banks to re-build their image in the eyes of the public, and the implementation of large scale Conduct programmes (mandated by regulators for the issues of purpose, conduct and senior management responsibility) to be given the necessary importance within banks’ governance frameworks.

What is different this time around?

In contrast to the last economic crisis of 2008, banks are being viewed as  a factor of stability in the eyes of governments and regulators. They have a key role to play in the support of the real economy. Banks are expected to deliver the lending support promised by governments and make urgent credit decisions. These decisions will have a huge impact on companies’ survival, staff employment and the ultimate economic consequences of the crisis.

Banks have been warned by the regulators not to increase dividends or bonuses following the relaxation of some of the capital requirements (such as the countercyclical buffer) and expectations are that distributions will be scrutinised by senior management and boards^[2]. Capital buffers are intended to help maintain the provision of key financial services to the real economy in periods of systemic stress.    

However, is it socially responsible for banks to lend to corporates whose business models were already unviable prior to Covid-19? These corporates  can now have access to a line of credit which results in transfering risk to the banks without any probability of repayment.

Banks will have to deal with the effect of non-performing loans on their balance sheets if the political pressure to be seen to support SMEs replaces prudence and sound risk management decisions. This could ultimately results in punitive capital treatment in the long term

European banks have written to the European Commission, European Central Bank and European Banking Authority to advocate for a moratorium^[3] tool that would allow banks to restructure the payment schedule of borrowers affected by Covid-19 without detriment to their prudential evaluation. Regulators and banks have a challenging line to tow, the former in adjusting prudential requirements and the latter in applying judgement when making lending decisions …

A paradigm shift?

As banks craft their response to Covid-19 and are called upon by central banks and regulators to play their part in keeping the economy going, is there a change in expectation as to what the purpose of a bank is and the role it should play in the economy?

The FCA recently published Discussion Paper, DP 20/1 Transforming culture in financial services: Driving purposeful cultures seems to imply so^[4] :

“The direction for firms to be more purposeful is not just an FCA objective, but is increasingly a broader societal expectation. There are ever more insistent calls for firms and their leaders to step forward on climate change, on diversity and inclusion, on ESG (environmental, social and governance issues), on ethical use of data, on acting in the best interests of customers and not just to act so as to optimise profitability. Many of these societal demands for change could lead to legislative and policy change ensuring that firms have a purpose beyond just making money.”

So, if there is a paradigm shift, what can banks do to demonstrate their commitment to being more purposeful and meeting society’s expectations?

The relevance of Principles for Responsible Banking

The United Nations Environment Programme Finance Initiative (UNEP-FI) launched,, the Principles for Responsible Banking (PRB)in September 2019. This was signed by over 200 banks in 60 countries. This provides a framework for a sustainable banking system, demonstrating the banking industry’s contribution to achieving society’s goals as expressed in the Sustainable Development Goals and the Paris Climate Agreement.

As society’s expectations change as a result of Covid-19, the PRBs provide banks with a new opportunity to be transparent about how their business conduct and response to the crisis meets these new expectations by adhering to:

• Principle 3 to “work responsibly with clients and customers to encourage sustainable practices and enable economic activities that create shared prosperity for current and future generations”.

• Principle 4 to “proactively and responsibly consult, engage and partner with relevant stakeholders to achieve society’s goals”.

It is clear that banks have already taken many measures to support clients (retail and small businesses) and communities, (as evidenced by the examples of Covid-19 responsible action taken by PRB signatories and published on the UNEP-FI website^[5]), the reflection on purpose and impacts required when implementing the PRBs can only be beneficial to banks as they re-set their strategies for the next decade.

What can banks do?

A number of banks have started to implement the Principles for Responsible Banking. As a starting point, banks need to assess how their current business practice demonstrates compliance with the PRBs. This will be through identifying areas where their business impact is positive and aligns with Sustainable Development Goals and areas where current practice could be improved. Senior management then needs to agree targets that the bank can work to; this will evidence its adherence to the PRBs.

Boards and Senior Committees can take this opportunity to review their current governance arrangements relating to Sustainability and ensure that regulatory expectations are met.

They can also take advice as to where their strategy on Sustainability and Climate change puts them in comparison to competitors and identify any existing best practice they should be aligning to.

^[1]https://www.prospectmagazine.co.uk/magazine/how-to-tame-global-finance

^[2]https://www.bankofengland.co.uk/prudential-regulation/publication/2020/statement-by-the-pra-accompanying-measures-announced-by-the-fpc

^[3]https://www.ebf.eu/ebf-media-centre/ebf-calls-for-european-measures-to-face-covid-19-outbreak/

^[4]https://www.fca.org.uk/publications/discussion-papers/dp20-1-transforming-culture-financial-services-driving-purposeful-cultures

^[5]https://www.unepfi.org/banking/bankingprinciples/responsible-banking-in-the-covid-19-crisis/