How Corrupt Are the Banks? Corrupting Cultures.

“Rigging the system to fix their bonuses. The word “corruption” is not enough to describe what they were doing.”

 

So stated one expert observer on Radio 4’s Today programme this morning (November 12, 2014) about the Foreign Exchange corruption in the world’s banking systems. UBS, RBS, Citibank, JP Morgan and HSBC were fined $3.4bn and Barclays is still to settle.

 

The travails at Tesco on which I have recently written, appear almost trivial beside the corruption (and, yes, “corruption” is the word to describe what was happening) that pervaded the western world’s banking systems leading up to and well beyond 2007.

 

The Bank of England apparently feels exonerated by the fact that no-one there knew anything about the foreign exchange mis-dealings at the five (or six) banks now fined. Just like the protestations at Tesco’s auditors (PwC) who, after 30 years, knew nothing about the culture changes that were at the root cause of Tesco’s recent failings.

 

Culture is the root of corruption

 

Francis Fukuyama in his excellent books “Political Order and Political Decay” and “The Origins of Political Order” showed how culture is at the root of society at the national level.

 

This is as true of companies – complex adaptive systems if ever there were any – as of nations. Companies are directed entities and depend on senior management and Boards allied to the competitive and regulatory environment in which they exist for the culture that they employ. The culture of every business is different – depending on the specific people they employ, the rules they employ, the country and region they exist in and the external environment.

 

The culture of any business organization is not a secret to those working within in it and is not a secret to those who work closely with it.

 

When a culture goes bad, as it clearly did in the case of Tesco and on a much broader and deeper scale in the case of the banks, it is not sudden and evolves as a result of changes that are both internal and external. Culture change has been the topic of many books and papers since well before the advent of quality management and Deming but these books tend to dwell on how to improve the culture to one of quality control or of “excellence” (as in Tom Peters’ “7 S’s”).

 

Unfortunately, there is little literature on how to understand corrupting business cultures in order to make changes that impact early enough so that customers, the business and shareholders are not hurt. The issue with banks is that nations have been hurt as a result of the toxic atmosphere in these institutions and the noxious emissions that resulted.

 

This cultural health and safety aspect of banking is clearly not understood by regulators (nor, indeed, by Directors and Audit Committees let alone external audit firms). Regulations are all about legal change and regulators are, to a large extent, ticking and checking against a set of procedures in the same way that external auditors carry out their roles.

 

The prime aim of such regulators seems to be to do a job so that they cannot be blamed for any failures. The Bank of England – crucial to the proper oversight of our financial systems – has failed so often in the past ten years but now seems comforted that no-one inside the BoE knew what was going on. RBS’s own (relatively) new CEO (Ross McEwan) voiced his anger on the BBC at the actions of “a very small group” of foreign exchange traders ruining everything for the many good people that work for RBS. He was asked the right question by the BBC interviewer (Kamal Ahmed) – “is culture changing enough”? McEwan responded that it was not changing quickly enough. But, the bad culture became institutionalised (as Ian Fraser’s excellent “Shredded” showed)  and the thought that senior management did not know of such a culture existing within such a key area of the bank is too sad to be true.

 

Walk into any office of any organization and any seasoned business manager will detect the culture. Ask some questions and listen to the responses. Any organisation is based on how its culture works and who benefits from that cultural response to its aims and ambitions.

 

Short-termism, where bonuses are made through short-term risk-taking and often corrupt dealing, is bred in cultures that are knowable. For management to claim not to be aware is ludicrous. As many senior bankers said around 2008/9, they knew the culture was wrong but could not stop it as everyone (every bank) was the same – no-one was willing to stop.

 

Fukuyama describes well how corrupt societies work where lack of trust exists around the centre (e.g. government) and where corruption is rife. No-one is wiling to be the first to pay their proper taxes, for example, if no-one else does. The same was true with the banks – everyone was corrupt, so who was going to stop the game? No-one. Now, no-one trusts the Banks – supposedly, a central plank on which wider society floats.

 

With the foreign exchange corruption, which occurred much more recently, there seems to be little or no excuse. The banks have been going through huge structural re-assessments since they sank in 2008 and senior management were being changed along with it. The Bank of England should have been focused on critical market areas (Foreign exchange transactions in London – 40% of the world’s transactions take place here – are hardly trivial) and should not have been unaware of the overhang of a corrupt culture in UK banks. To claim otherwise is nonsense.

 

The culture within regulators has to be changed along with the banks. While no-one claims they are corrupt cultures, a culture of defensiveness, box-ticking, shifting blame and lack of knowledge is the worst cultural set for a regulator. They need (like external auditors) to be responsive to societal needs – not tick and check but pro-actively understanding the organisations they are supposed to be regulating (or auditing). This is not an easy task for organisations that appear to be completely incapable of doing this important job – not wanting to rock the boat before it sinks. But, rocking the boat may throw out those who are bent on sinking it before it sinks – that is what good regulation (or auditing) is all about.

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The Second Great Wall of China

Reading Martin Jacques’ “When China Rules the World” during a week when the New York Times’ website was taken offline in China after it published claims about the wealth of Wen Jiabao. News about Mr. Wen’s alleged fortune of £1.7bn was characterized by the Chinese as a “smear” and resulted in news blackout on the subject. The BBC was similarly off air for months after its detailing of the Bo Xilai case.

 

Jacques’ well-documented book shows China as a “civilization state” that the West will not be able to challenge in its essential ideals based on 2,000 years of civilization and then Confucianism. The desire of its people – massed in a vast area with one-third of the world’s population – for solid government and their Confucian appetite for family connections leads many to believe that their form of government and control is the only way for China and that the rest of the world will not be able to change it.

 

The Wall of Legalism

 

Francis Fukuyama in his excellent book “The Origins of Political Order” http://www.amazon.co.uk/The-Origins-Political-Order-Revolution/dp/1846682576/ref=sr_1_1?ie=UTF8&qid=1351345981&sr=8-1on focused how the origins of the rule of law was central to the proper governing of a state. Success, where no government or leader was above the law, is contrasted with such states as China, where, except for brief period, the ruling elite has been above the law.

 

Many believe that a state with Confucianism on the outside and Legalism on the inside is how China is governed today. Legalism, a creed formulated and emerging properly in the Warring States Period up to 221bc, seeks to ensure that strict laws keep dissent down and people equal. The Emperor was in place because of the law and was above it – but had to be flexible in intent to ensure that the leading cliques were satisfied.

 

Coming forward 200 years and the so-called Communist Party has assumed the role of Emperor. A Communist Party that that no longer believes in Communism but in power from the centre; that not just tolerates corruption but uses it throughout China to keep its leading cliques in check; that exports corruption to its supply-chain (its raw materials suppliers) throughout the word in order to keep them sweet; that deals harshly with any dissent and criticism; that only reacts to the worst crimes and then only when it has to (such as with Bo Xilai – who became too much of a burden).

 

Legalism as a creed best describes the current Chinese government style – no longer driven by the equality of Communism – where a ruling elite has taken over the State and drives it according to their own requirements.

 

The post-World War II political and economic direction of the West has been democracy and capitalism. Human rights enshrined in the Universal Declaration of Human Rights http://www.un.org/en/documents/udhr/index.shtml has been a solid framework on which political thought has been based. The development of the European Union (notwithstanding economic upsets through the Euro) was based on this political fulcrum and a liberal economic system.

 

This post-war consensus in the West has also been the basis on which we have tried to hold the rest of the world to account – to develop democracy and capitalism on a worldwide basis.

 

No use for Wallpaper

 

Now, the western consensus is threatened by China. Having taken the economic principle of capitalism and thrown the centralized system of communism into the gutter, the Chinese are rapidly gaining economic muscle. This was not surprising once the shackles of the communist economic model was broken and Deng XiaoPing was able to redirect the Chinese to a better economic future.

 

This had already had enormous impact in China as wealth has increased and will continue to do so. But, a country with huge numbers of people but limited natural resources (apart from their own intelligence and rare earth minerals) has to then engage with the rest of the world in order to maintain that direction of travel.

 

This is now breaking down the political and governance consensus that the West has tried for the last sixty-seven years to impose. What does this mean? It means that the Chinese are overturning the route to democracy and democratic institutions. It means that elites in developing countries now have huge financial backing from the Chinese – through sales of raw materials to China and through the fact that they are witnessing another political model.

 

The West cannot wallpaper over the political cracks in the political wall. While capitalism is clearly now shown to be the best worst system of improving our material wealth, democracy is no longer the only political product on sale. After the bloody years of fighting against communism and fascism, which World War II was supposed to have won, the challenge is not so much religious fundamentalism (which we have been understandably so fearful of) but the enormous influence that China will have on a world where the most serious challenge to democracy is arising.

 

Taking a brick from the Wall

 

The battle for ideas is just starting. China needs a healthy west and a healthy India and Brazil and rest of Asia and it needs the raw materials from across the planet. Apart from the environmental catastrophes that are likely to be exacerbated by the drive for material growth (upon which the Chinese legalist approach relies in order to keep its people happy), the influence of Chinese political thought is likely to grow exponentially.

 

Recent riots in Ningbo –   http://www.bbc.co.uk/news/world-asia-china-20109743 – against a chemical plant expansion and the Chinese authorities’ methods of dealing with it (which includes the hiding of road signs so that journalists won’t find their way to the riots!) are a simple sign that Tiananmen Square was by no means a low point.

 

As the world waits for the US Presidential election, a change of at least equal importance will be taking place in Beijing and no-one will know who has come out on top until the new politburo of the Chinese Communist Party is unveiled around 15 November.

 

Not that this will change anything. In the US, the economics will be substantially changed by the possible election of Romney and (Ayn Rand influenced) Paul Ryan. The political system will not change.

 

In China, nothing will change and the political, legalist system will continue internally and externally. This is a continuing challenge that is currently seen as economic but will eventually be seen as dramatically political and on a world scale. For Chinese economic growth will challenge the democratic ideals built up by the West and hard fought for by millions. It is now ranged against 2,000 years of Chinese centralism legalism.

 

How (or if) the West reacts to this will be a far bigger story than the economics – and arguments over tariffs and who owns Treasury bonds. We need to start taking the brick from the Wall before it is built around us.