Module 101

Business Ethics and Compliance

 Module Covers

Business
Business ethics and Case study
Ethics and Ethical Compliance on Wells
ethics and agency
morality dilemmas relationships Fargo
trust
in banks
CHAPTER 1

Ethics and Morality

Ethics and Morality

ETHICS
MORALITY
“The agreed standards of what is desirable
“The generally accepted standards of what is
and undesirable; of right and wrong conduct;
desirable and undesirable; of right and wrong
of what is considered by that group as good
conduct, and what is considered by that
and bad behavior of a person, sub-group, or
society as good behavior and what is
entity that is a member of the group, and may
considered bad behavior of a person,
include defined bases for discipline,
group, or entity”.
including exclusion”.
Approaches to Ethics

Motives Matter Most Ends or Consequences Virtue Ethics

Matter Most
Motives, Acts and Consequences

Kantian ethics focus on the motives of the decision maker in relation to universal laws, and his first
formulation can be summarized thus:
Motives
“Act only in accordance with that maxim through which you can at the same time will that it become a
universal law”.

Bank staff should act only to do what is right. Two implications arise:

Acts • Doing what is right is independent of the consequences of the decision taken by bank staff; and

• Doing what is right is independent of the bonus or incentives earned by bank staff.

The theory of ethics that focuses on achieving right outcomes or consequences is attributed to noted
philosophers Jeremy Bentham and John Stuart Mill. There are two dimensions to this theory.
Consequences
1. Only the results of a decision matter.

2. The results must deliver the greatest good for the greatest number of people.
Basics of Deontology
What are universal banks and what is the problem?
Virtues of the Actor: The Third Approach to Ethics

MOTIVE ACT ENDS

VIRTUES
OF THE
ACTOR

Virtue ethics appeal to human values of character and integrity – the actions of
the decision-maker proceed from his/her character.
Qualities such as empathy and integrity are important in creating a relationship of trust.
Virtue Ethics Summarised
Ethics Defined: Consequentialism
CHAPTER 2

Ethical Dilemmas
Ethics Defined: Consequentialism

An ethical dilemma arises when we

must choose between what is right
(moral) and what is wrong
(immoral).

Managerial decision-making
becomes more difficult when ethics
are translated into action.

The question of what is right and

what is wrong must be decided
before the decision is to be made.
Determining What Actions are Wrong

Actions are wrong if they:

1. Violate societal values, norms

and practices; and

2. Are self-serving at the expense

of others

People who have integrity are more

likely to consistently choose right
over wrong.
So, how does a banker choose right over wrong?

We suggest the decision maker uses an approach akin to that put forward by Badaracco (1997). Each
member of bank staff should start with a process of reflection by asking the following questions:

Who am I? What are my Who are we? Am I / are we asking

moral foundations? the right question?
How do we choose between right and right?

We have considered the decision between right over wrong.

But it is harder when faced with two situations that can both be right.

Badaracco (1997) calls these ‘defining moments’, and suggests that the decision maker should
adhere to the following four-step process when choosing between two ‘right’ decisions:

1 2 3 4

Analyse the situation Be clear on his/her values Be aware of and sensitive Understand the long-term
carefully and accurately and strength of to the values of others effects or results of
without bias attachment to those making one choice
values over another
Joe Badaracco – Ethics and Values – Don’t be a Hero
The customer
comes first.
Bank profits
will follow.
CHAPTER 3

Business Ethics and Trust

Business Ethics

From an academic standpoint, business ethics involves the systematic study of values – a branch of
philosophy – a position that underlines Nash’s classic Harvard Review (1981) article.

Business ethics in particular considers the standards of human behaviour (and business behaviour)
based on moral principles established by philosophers.
What does professional ethics mean?
Trust

If trust slows down, consumers slow down their demand for goods and services
and hence costs rise. (Stephen M. R. Covey, The Speed of Trust)

The long-term concern for financial institutions depends not only on

financial performance but also on corporate reputation for fair dealing.
Maturity Transformation: An Interview with Phil Dybvig
The Retail Banker’s Oath

“I declare that as a retail banker I will act with integrity in

the interests of bank stakeholders and society at large.

I will prioritise clients and advise them to the best of my ability. I will comply with
all laws, regulations and codes of conduct that apply to me as a retail banker.

I will maintain strict client confidentiality and hold myself accountable.

I will not abuse my position, on the knowledge obtained in it.

I will make a sincere effort to preserve and promote trust in the banking sector
and will honor the profession of a Banker”.
Overcoming the Principal-Agency Problems

Others Depositors

Debt Holders
Shareholders
The Principal Agent Problem
CHAPTER 4

Business Ethics and Agency Relationship in Banks

The Principal-Agent Model of Modern Business

Managers
Owners • are involved in the day-to-day firm activities.
• are often passive investors. • set strategic direction.
• understand the firm’s competitive landscape.
• have a better forecast on the future profitability.

A conflict of interests between managers and shareholders is called ‘goal incongruity’.

“Principal-agent theory… is about how individuals manage situations

involving ‘goal incongruity’ between two or more persons” (Dees, 1992).
Agency Relationships Based on Information Asymmetry

The traditional The manager-debt holder relationship The manager-depositor relationship

manager-shareholder relationship
Agency Relationships Based on Information Asymmetry

Managers who are guided by a moral philosophy that is based on egoism

(self-interest) may behave in a manner that is not in the interest of other
stakeholders, and may even overindulge in perquisites.

The lack of optimal monitoring may lead to this ethical problem.

Agency Theory and Culture

Agency theory can give us a theoretical understanding as to why agency cultures exist and
how the resulting ethical problem can be identified and resolved.

Internal Interventions may include:

Dividends or debt can be used as Bank managers must hold capital Internal actions to limit unethical
tools to reduce excess free cash to cushion unexpected losses behavior have been crowded out
flows arising from excessive risk taking by external incentives
Prisoner’s Dilemma and Trust

The lesson: suboptimal behavior is the result of short time frames and superficial relationships.

Superficial relationships and impersonal contact

Trusted relationship based on interpersonal contacts 
(especially if infrequent) would engender a Prisoner’s
optimal results.
Dilemma  suboptimal results.
CHAPTER 5

Compliance
 A bank’s compliance function can be
defined as an independent function
that identifies, assesses, advises on,
monitors and reports on the bank’s
compliance risk, that is, the risk of
legal or regulatory sanctions, financial
loss or loss to reputation a bank may
suffer as a result of its failure to
comply with all applicable laws,
regulations, codes of conduct and
standards of good practice.
Compliance

Describes the case where the bank

complies with the external rules that
1
are imposed upon it as an
In the context of organisation
retail banking,
compliance is
focused on two
levels.
Requires compliance with internal
systems of control that are imposed
2
by senior executives to achieve
Level 1 compliance.
 In relation to the goal of creating an
ethical bank culture, compliance with
applicable laws, rules and standards
should NOT be viewed as the end but
rather as a means to promote the values
of honesty and integrity
Compliance Risk

Compliance risk is the: “risk of legal or regulatory sanctions, material financial loss, or loss to
reputation a bank may suffer as a result of its failure to comply with laws, regulations, rules, related
self-regulatory organisation standards, and codes of conduct applicable to its banking activities”
(BCBS, 2005, p. 7).

Compliance risk can:

1 2 3 4

Impair bank integrity Damage brand Cause sanctions and Make it difficult to acquire
financial loss new customers
Compliance risk is synonymous
with integrity risk.
Compliance Risk

Compliance laws, rules and standards generally cover (BCBS, 2005):

1 2 3 4

Observing proper Managing conflicts Treating customers fairly Ensuring the suitability of
standards of market of interest customer advice
conduct
What is money laundering?

The process by which criminals disguise the original ownership and control of the proceeds of
criminal conduct by making such proceeds appear to have been derived from a legitimate source
(ICAb).

Three stage process of money laundering:

Placement Layering Integration

Legislation to reduce compliance risk

The USA Patriot Act The Proceeds of Crime (Money A similar intent is found in the
Laundering) and Terrorist Anti-Money Laundering/Combating
Financing Act of Canada Financing of Terrorism
Regulations 2009 of Nigeria.
Compliance Risk

The bank’s chief compliance officer is responsible for setting up compliance framework to:

1 2 3 4

Ensure that every bank
employee is fully aware of
the sources of compliance
risks and understands that
he/she has a duty to take
actions to mitigate them
Report non-compliance
incidents on a timely basis
to the board of directors
and senior management
Implement changes in
compliance standards
when required
Professionals at all levels
have a duty to identify and
intervene in cases of
misconduct, whether
deliberate or accidental
CHAPTER 6

Case Study on Wells Fargo

Case Study on Wells Fargo

Ranked 22nd
most admired company in the world

2015

Ranked 22nd
most respected company

Ranked 7th
on the Forbes Magazine Global 2000 list of largest
public companies in the world

2016

Ranked 27th
on the Fortune 500 list of largest companies in the
United States.
Scandal at Wells Fargo

September 2016

• Wells Fargo employees had been ‘delivering’ on the

demanding targets established by their executives through
fraud and deception.

• The size of the scandal became clear as it emerged that

for several years prior to this, staff had been opening
unauthorised deposit accounts and issuing unauthorised
credit card applications.

• Any form of ‘gaming’ to receive compensation, to meet

sales goals, or for any other reason, is in direct violation of
company policy and Code of Ethics.
Elizabeth Warren rips into Wells Fargo CEO
In September 2016, CNN Money (Egan, 2016) ran an article online which captured the culture of
Wells Fargo as seen through the eyes of staff members at the bank.
As a consequence…

The direct costs of its troubles have been relatively small.

The biggest cost to

Wells Fargo has
$80m for the unwanted $142m to settle a class- probably been paid by
car insurance action suit its share price.

1 2 3 4 5 6

It is in the process of $185m for fines A little over 40% has

paying $11m for already been clawed
refunds and back from various
compensation tied to executives.
the account openings.
Summary

This module dealt with business ethics and compliance.

Chapter 1 considered the moral Chapter 2 established a link Chapter 3 went deeper into why
principles underlying business between business ethics and ethical lapses may occur as they
ethics. customer trust. have been manifested in mis-selling
to customers.

In Chapter 4 it was recommended Chapter 5 considered the fundamental Chapter 6 presented a case study
that the personal ethics of bank staff issues of compliance risk, which is on ethics focusing on the recent
be aligned with the organisational identified with integrity risk. troubles at Wells Fargo.
culture of the bank.
End Of Module