Month: October 2020

Investment bankers are renowned for their ability to be paid large sums of money. But perhaps the tide is turning against a culture that puts the investment banking bonus pools ahead of all other stakeholders in a bank’s profits. This week the Financial Times reported that for several large universal banks with large investment banking operations there will be pressure to be conservative in the payment of bonuses, even if portions of the investment bank have made record profits.

Universal banks provide a strong balance sheet, reputation and client access to support the work of their investment banks. But that strength comes in part from the build up of capital in these banks. And the shareholders as well as other stakeholders for these large banks also have expectations. As noted in the article, one “bank (is trying) to balance paying people for results with their need to be “good citizens”. This is in an environment where regulators and politicians have curbed shareholder payouts so they will have a cushion for potential loan losses.”

It could indeed be a sign of the end of the “heads I win/tails you lose” culture that has predominated within the investment banks of the large banks. A culture where losses are always absorbed by the bank and not by the individuals and teams that may have been responsible for them. It is not clear that this positive development will be realised but the fact that it is being discussed is clearly a very first step in the right direction.

Building wealth and prosperity is a goal for nearly everyone. But not all have the same chance to do so.

Historically home ownership and small business ownership have been two very important routes in the US to build wealth. It is well known that home ownership for minorities, especially Black people was limited by the practice of red-lining – arbitrary lines drawn in red around neighbourhoods where no mortgage loans were made. Or maybe the lines were not so arbitrary as those neighbourhoods were predominantly populated by Black people.

A recent article published by the Portland Business Journal highlights how red-lining also appears in small business lending. As noted “(a) July SBA Office of Advocacy study, which used Federal Reserve data and adjusted for credit risk, showed Black-owned businesses faced “the biggest challenges in obtaining their desired financing.” The study cited nine academic papers that came to the same basic conclusion.” The article also noted “(e)conomic experts say the trends exacerbate racial disparities in wealth generation, homeownership rates, educational attainment and other vital rungs on the American dream’s financial ladder.”

This pattern illustrates just another way in which racism is embedded in the US banking system. And that embedded racism has real consequences for the wealth creation needed by all communities.

This week I came across two articles that reminded me that investors and regulators can be two of the key drivers of a more sustainable and equitable financial system. On 11 October Gene Ludwig provided insightful commentary in the Financial Times on the role regulators can play to ensure that communities un(der)served by banking institutions the more attention they need. Ludwig focuses on how the Community Reinvestment Act (CRA) provides a framework for ensuring that banks serve the communities that serve the banks by providing them with deposits. Importantly Ludwig notes the need to go beyond the traditional CRA approach focusing on physical branches as banks move increasingly to on-line platforms to meet client needs. He also notes that this requirement needs to be extended beyond banks to cover a wide variety of other financial institutions. Finally he notes the important role played by Community Development Financial Institutions (CDFIs) in meeting the needs of local communities – especially as they deal with the impact of COVID-19.

The role of CDFIs can only be provided if they have sufficient capital – real equity capital. This need is real as CDFIs can not grow their impact without equity to support the risks they assume in their banking practices. George Surgeon and Laurie Spengler highlight this need in an article in ImpactAlpha published on 23 September. Most importantly they note that a focus on only providing deposits to CDFIs is not sufficient . Furthermore the amounts that would make a difference for the capital strength of CDFIs is minimal when compared to the financial resources of the large corporations that have stated their desire to take action to create a more just and equitable society.

Southern Bancorp provides a case study in what these two articles are preaching. In an article from July in Next City, Darrin Wiliams (CEO of Southern) provides a clear statement of what is needed to be an “anti-racist” bank. The steps are not so difficult but there are very few banks showing the leadership of Southern in this area. Time for more banks to learn how they can make a difference – and how regulators and investors can support and drive the needed change.

In the last week there was a number of articles related to pressure for financial institutions relative to a variety of sustainability goals. The greatest step back was the decision by the EU to delay its deadline to implement anti-greenwashing rules for investment managers. This delay was sought by fund managers that did not feel they could comply with the rule given some of its complexity. As reported in the Financial Times, the framework would still be in place from March 2021 but there would be a delay in the reporting requirements. So maybe it was only a half step back but nevertheless not going in the right direction.

On the other hand there were numerous stories (five of which I came across) that suggest the pressure on all financial institutions and other companies to be more sustainable is only growing. Of interest is that these are increasingly focused on the financing provided to companies and projects that are not addressing issues of climate change.

• The Financial Times reported that several investors were pressuring Samsung’s insurance units regarding their financing of climate change negative projects and companies.
• Then the new head of the Norwegian oil fund noted also in the Financial Times that they would be carefully looking at ESG criteria when making investments.
• Perhaps reacting to pressure on the disconnect between their practices and the words of their CEO, BlackRock is requesting at the annual general meeting that AGL (an Australian power company) speed up closing its coal-fired power plants.
• Next up was an opinion piece in the New York Times from heirs to the Rockefeller fortune (made in oil and gas I would note) stating that “JPMorgan Chase and other big banks should use their lending power to force cuts in greenhouse gas emissions.”
• And finally came HSBC with a commitment to be fully carbon neutral in its financing activities by 2050 as reported in the Financial Times.

So whilst the news is not always about progress and the timing could be considered too slow (looking at you HSBC), the trend is clear. ESG and climate change are topics where financial institution and companies will be pressured by investors to improve their work.

Operational risk continues to cost banks a lot of money. Just this week it was the turn of Citibank to pay a substantial fine ($400 million) for internal operational issues As reported in the New York Times, Citibank is paying this amount to the Comptroller of the Currency for failure to fix problems that have been identified over several years.  Coincidentally (or not) the fine is being paid just “(t)wo months after one of its bankers accidentally sent nearly $1 billion to the wrong people.” A mistake which Citibank is trying to correct but where the recipients of the money are not agreeing to return it. The New York Times article goes on to note several other operational mistakes that have been reported. One can only speculate about the mistakes that have not surfaced publicly.

One of the key principles behind ESG investing is the element of strong Governance. Among the key elements of Governance is strong operational controls that minimise mistakes. Clearly in the case of Citibank there are issues in this area that lead not only to direct losses such as may occur with the mistake in transferring funds but also in the costs of the fine to be paid for internal operational issues. The appointment of a new independent committee of the board to focus on these issues is a good start. But that begs the question as to what the board was doing in the past.

Earlier this year BlackRock’s CEO Larry Fink noted the risk of climate change. More information on BlackRock’s approach can be found on their website. However, as noted yesterday in the Financial Times, this commitment has not extended to how they have voted their ownership positions in major companies. In fact BlackRock “supported just 6 per cent of environmental proposals filed by shareholders globally in the 12 months to June, down from 8 per cent in the previous year.”  There is appropriate scepticism among environmental activists about the difference between what is said and what is done. And so BlackRock would seem to be another example of not walking the talk. Further evidence that greenwashing remains a serious issue.

Like many others, I frequently receive e-mails that are all about phishing for my personal data so someone can defraud me of money from my bank accounts. But it appears that banks have also been active with fraudulent activity – not through phishing but through spoofing. And their spoofing activities are proving to be costly as JP Morgan paid a fine of nearly $1 billion as announced last week in the Financial Times. This is yet another example of how banks create financial costs from inappropriate behaviour and culture. And if you were an investor in JP Morgan the appropriate next question would be how much of that fine was recovered from bonuses paid to the individuals involved. I suspect not one red cent.

In a further article in the Financial Times it was noted: “US authorities criticised JPMorgan for failing to fully co-operate at the outset of their inquiries. The Department of Justice noted that the bank began suspending suspected traders on its metals desk only after a second person had pleaded guilty.”  This article noted that the issue is not only for JP Morgan but has also impacted Deutsche Bank where two traders were found guilty of similar behaviour and are facing up to 30 years in jail. And so just a banks want us to be cautious about phishing, it seems like it is also time for them to be cautious about their own spoofing.

In September there were increasing signs of risk in the financial markets. Early in the month the Financial Times reported on worry about real estate lending in the US. There was a 42% increase in loans under stress according to this article. As noted: “The financial consequences of shutting swaths of the US economy to deal with coronavirus are still just becoming clear, as many hotels remain empty, shopping mall traffic is subdued and office workers remain at home. ” But one could argue that this is only the tip of the iceberg as the world adjusts to a post-COVID-19 world. Whilst the article refers to “shutting,” it is more likely the case that individuals are also taking actions to work from home, shop by internet, and travel and eat out less frequently. Many of these patterns are only going to continue or get stronger suggesting that the historic valuations for commercial real estate may not be sustainable.

Later in September, Gillian Tett (also in the Financial Times) noted that “(f)ears of a credit crunch have already hit business confidence and worried banks.” She goes on to provide other evidence from a variety of sources regarding stress in the economy. She notes: “the key point is that chronic stress can be very economically debilitating.” I do not think there is anyone who would dispute that we are in a period of “chronic stress” not only from the impact of COVID-19 but also from political uncertainty and the challenges of societies dealing with embedded systemic racism. Clearly a time to be cautious.