Regulation is not enough. For the financial services industry to restore public faith, it must make drastic changes to its “fundamental, underlying culture,” John Taft, CEO at RBC Wealth Management – U.S., said at a CFA Institute event in Washington, D.C. today.
He cited a number of industry sources in explaining what has sullied the image of financial services.
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Barclays new CEO, Antony Jenkins, was quoted in the wake of the Libor scandal as saying the industry “has lost sight of the customer,” adding banks must “become socially useful if they are to rebuild trust.”
Financial Times journalist Gillian Tett has said “the finance world’s lack of interest in wider social issues cuts to the very heart of what has gone wrong. Financiers have come to regard banking as a silo in its own right, detached from the rest of society.”
This failure to live up to “their end of the social contract,” Taft says, is the root of the lack of confidence the financial services industry faces.
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“Where cheating and mistrust and broken promises prevail, markets are shrunken and reduced to barter and economic minimalism,” Taft says, quoting Stephen Young’s book, Moral Capitalism.
The first consequence is “we are now in the middle of the single largest rewriting of the rules of the financial regulatory infrastructure in our lifetime,” Taft says.
While regulatory reforms are an important part of the solution, no amount of new laws and regulations can bring about the changes needed to restore the public’s confidence in financial markets and its intermediaries, according to Taft.
He also suggests the new regulatory regime goes too far, and will likely suffocate economic growth. The reforms are not only excessive but “poorly sequenced and uncoordinated,” he adds.
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The second consequence is the effect on investors. Because of fear, they are over-allocated to what they consider to be safe assets—cash and bonds.
But these instruments have risks individual investors tend not to understand, Taft points out. The erosion of purchasing power due to inflation over the longer term is but one.
“This over-allocation to ‘safe’ assets deprives the economy of long-term risk capital, and it sets investors up for the near certainty that they will not be able to fund their liabilities into and through retirement.”
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Taft also suggested that not only the financial services industry but society at large is “infected with short-termism.
“Environmental issues, resource scarcity and income inequalities are all slow-motion train wrecks that require all of us—not just leaders in industry and politics—to behave like responsible stewards.”
Solving the problem
Taft is skeptical that codes of ethics alone will be enough to turn the tide.
“You have to start with leadership and developing a different vocabulary, and demanding a different type of behaviour. We have to embrace regulatory reform and do what we can to get it right.”
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Taft adds investor activism may help keep the industry accountable.
“Investors demanding of the corporations and governments they invest in that they behave responsibly and hold up their end of the social contract is one of the surest ways to effect behaviour change on the part of the leaders of those institutions,” he says.