26 March 2014
A Parallel Earth or a Brave New World
Lady Susan Rice CBE
Thank you very much, Michael. I believe it was Private Fraser in Dad’s Army who was fond of uttering the words “We are doomed – we are all doomed!” Maybe funny in that context, but our focus today is on the place of measurement in a sustainable banking sector, which is of course what we all want, but some continue to challenge the likelihood of ever getting there. Indeed, I have heard people say it will only happen in a parallel universe – in other words, we are all doomed! Such challenge notwithstanding, Long Finance and those associated with this initiative believe that there is a better way for banking in the future. I think so too and that is why I am so pleased to be here for your Spring Conference. I find the concept of long finance quite compelling, to the extent that I understand it, because it potentially mirrors what happens in reality, and if there is a paradox between the words “long” and “finance”, we have to find a way around it. Since many of you are experts, I believe, of one sort or another - investors, economists, regulators, academics, policymakers, pundits, bankers – I would say simply that, whatever the theory or concept, it is important to do a reality check, to make the case from the real world and that is what I am going to do just now.
So, I just mentioned the parallel universe, Philip Pullman, master of such, once said, after nourishment, shelter and companionship, stories are the things that we need most, so I shall draw on a few stories from my own professional experience in response to three questions that I would raise. First, are we right to assume that a stool can only stand on two legs, that a bank is sound in the longer term if, one, the numbers look okay, and two, the executives say the right things, the intention is right? Second, as we become smarter, with the mechanics of banking, at managing capital and liquidity and market risk in an ever more sophisticated way, is it important or not that we keep in touch with the core purpose of banking? Third, there is no doubt that measurement drives us. I absolutely agree with that premise – numbers are one fundamental interpretation of reality. But what about the human element, the anecdote, the judgement, the story – is there a place for those interpretations as well, alongside measurement? I will start with banking, mention a couple of other industries, then return to banking at the end, touching on these three questions.
My first story dates from about fifteen years ago, from New York, where I was working at the time. My job there was in what we might call Project Finance, funding large-scale building developments. At one point, a rogue developer – and I call him that because he was a bad guy and he went to jail eventually – but he abandoned a shopping mall, half-built in the South Bronx. Now, that was the poorest congressional district in the US at that time. I think it probably still is. That left us in the bank with a massive bad debt and, even worse, it left that community with yet another visual manifestation of abandonment.
Regulation required us, as a bank, to book the loss and walk away – that is what you do. However, we did something that had never been done before: the bank became a developer as well as a financier, and we completed the project. But to do that, we had to work outside the rules completely, the rules on credit, on provisioning, on how to structure debt, which we did. We did it openly and transparently. We told our regulators – they rolled their eyes, quite honestly, but we did manage and turned a bad debt into a good one, but more importantly, we created jobs and services in that community, where there was a huge pent-up demand for that. We expanded the project, added office space, created a centre, a marketplace, if you will, and even added a cinema to the development. It was the first one ever in the Bronx, and more people saw The Lion King at that cinema when it first came out than anywhere else in America – talk about pent-up demand for something!
So, I have just described some social benefits from this project, but there were actually financial benefits as well because the financial case for the project was based on creating new jobs and on turning what was an urban desert, literally, into an area that people would actually come to. Office workers were willing to work there because there were shops and eateries right on the doorstep, which meant that these small shops and restaurants could survive because they would have custom, and that meant that the landlords and the shop owners would pay their rent, and all of this together would help to make a commercial success of the whole project.
This obviously is not long finance, as you think about it, but there is a seed of your concept in that experience, something around determining value based on activity beyond the identifiable numbers, beyond today’s outputs. This was a major banking transaction which we made commercial only by taking into account broader measures than debt and investment and return on capital or indeed what was the current value of the site, which was negative in terms of value – we had to ignore that. We threw the standard formula out the door. We made it commercial in part by factoring the future benefits of societal improvement into the economics of the transaction itself.
So, how did we get to that place? Well, initially, we were not actually driven by the numbers. We were not just saying: how are we going to make this work by a commercial motive? In the first instance, we were actually appalled at the behaviour of the behaviour, and we felt we simply could not abandon the people in this area. So, we talked about what we could do, and what we did not do was go out and distribute our largess, operating two parallel worlds, side by side. It was not a matter of corporate finance, on the one hand, and corporate philanthropy on the other, because the risk we had was not around how creditworthy the borrower was. We were, after all, lending to ourselves. The risk was to the future income stream needed to support the ongoing debt over time. So, we started with the community and the people in it, and asked them what they would value, and we worked back to reshape the whole project in order to give them some of what they needed, which made it likelier that we would see the future benefit we were looking for, and we then built that expectation of future benefit into the commercial, the business case, right at the start.
On the Long Finance website, you ask the question “When would you know that our financial system is working?” As an ordinary high street banker – as I said, all of you are experts, but as a fairly ordinary banker, I might answer that question by saying that we will make the financial system work if we not only address all of the risks that we can identify but if we also start with what the customer wants, and we deliver it fairly and openly and simply in order to reduce future risk and thereby create value. Banking is all about risk, and much of that risk of course is in the future. Yet, when we judge the performance of banks, as with any company, we focus on short-term financial performance, quarterly capitalism, very often, sometimes even on spot-numbers. We also do link some ongoing expectations for performance to capital or other surrogates for longevity. But what we are doing there is always measuring outputs. We sometimes also take comfort from what is called “the tone at the top”, the executives who are the face of the bank, both with investors and more widely. Are the executives telling us they are doing the right things and do the numbers stack up and confirm their claims? That is the snapshot we take – a bit of a two-legged stool.
Fair enough, but what about the thousands of people who work in the organisation? Does it really matter what they do, so long as the numbers add up at the end of the day and the bank is on-message? For some decades, in banking, at least, we have behaved as if it perhaps did not matter that much, as if, whatever the culture, the behaviours, the values of the staff, all was well if the numbers were good, but then we learned that those blinkers had to come off, and that leads me to my second story, which some of you may have heard me tell it at some other time.
So, this goes back about five years ago, February 2009. That was when the economy more or less hit rock-bottom, and it was also, if you think back, the point when, every day, the newspaper headlines, very large, bold, black type, were talking about vile bankers. An awful lot of bankers got out their sunglasses and thought they needed to go round like that – it was not a very comfortable time. I was in London. I got into a taxi to go out to the airport, and the taxi driver immediately said, “So, what do you do?” and I sat there and I thought, Oh, if I tell him I am a banker, he will give me a lot of grief because that is what was happening, and it has been a long day and then I thought, well, what else can I say? So, a little bit tongue in cheek, I said to him, “Look, I am a banker, but I am one of the good ones, and most of us are, so please do not stop your taxi and make me get out!” and, without missing a beat, he said to me, he said, “Oh, I noticed you hesitated before you told me you were a banker – well, I understand. If I was out on the pavement and someone said to me “What do you do?” I would not say I was a taxi-driver – you probably read in the papers last week about the London taxi-driver who was arrested for assaulting a passenger,” at which point I thought maybe I do want him to stop and let me get out!
That was a true story, but I took a chance, as one does, and it was a peaceful ride out to the airport, and I sat there thinking this is a terrible space to be in, that all of us who are bankers have just hunkered down and feel almost ashamed of being there. So, I sat there thinking, if I have a chance, I am going to find a way to talk about banking, to start helping the conversation as we look forward, because look forward we had to. I found opportunities came my way and did start speaking about the future of banking, as if it did indeed have a future, and I still believe it does. Banking is, after all, essential to how we operate in society. We cannot operate without a good banking sector – this needs to work. In a lot of these speeches and conversations, I have regularly shared my view that real value only comes if it is based with values, with an “s”.
Out of all of this came out of a programme, which we call the Chartered Banker Professional Standards Board, the PSB for short, Professional Standards Board. I was asked to chair this initiative on behalf of eight founding banks, including the five largest in the UK and several smaller ones, along with the Chartered Banker Institute. We began by developing a commitment to professionalism in banking, which sets out a vision for customer focused professionalism in the industry. The commitment is supported by a Chartered Banker Code of Professional Conduct, which our member banks have adopted and which defines the attitudes and behaviours required of individuals working in the banking industry.
Underpinned by the Code, and, for the first time ever in the UK, and most anywhere else, we are developing professional standards, and I hasten to say that standards are not qualifications, they are not exams, they are not what enables me to give investment advice or sell a mortgage. They are standards. They are about broad general knowledge and they are about ethics and behaviour. So, we are developing professional standards for individual bankers, for each one of us, and each of the standards covers both, as I say, the broad knowledge and the expectations for professional and ethical behaviour required of anyone, at any level, who works in banking. The Foundation Standard, our first, was published more than a year ago. Close to 80,000 bankers have already achieved it. The number continues to rise, and 200,000 will have achieved it in the UK by next year. A Leadership Standard is currently out for consultation. We are just about done with the consultation and we expect to publish it this summer, and a suite of specialist intermediate standards will be developed after that.
Together, the founding PSB banks, the eight banks, account for about 75% of the industry in the UK, serve more than 70 million customers here, so this is a real initiative, with real outcomes.
We did not want to give lip-service to this idea. We really set out to provide an explicit route map of training, experience, outcomes and indicators to ensure that we achieved it, and above all, we wanted to define professionalism for bankers.
Now, some of you may be sitting here wondering how does all of this work relate to the current Lambert Review, the Review that Sir Richard Lambert is leading on banking standards, and to put it very simply, what he is leading is looking at standards for the industry, for banks, for institutions, and there is the sort of whole broad panoply, while our work is about standards for the people, the individuals who work in the institutions, and through our two programmes, we have been having a lot of contact with each other, so they sit very nicely side-by-side. Each of us is developing voluntary standards and, taken together, we may have a genuine opportunity, we hope, to change the industry and how it is perceived, and these standards need to operate alongside the standards and the expectations of the regulators, so of course we are working with them.
By achieving the new professional standards with the PSB, we want bankers to feel pride in the service they give and help one-by-one to restore confidence in the work that they do, and confidence leads to trust, and we cannot have a strong banking system without trust. So, how do we know that? It comes through loud and clear in just about every survey that I have seen of the industry.
Last year, YouGov had a big survey, looked at a lot of industries, and then isolated the findings for banking. They reported that 82% of respondents believed that people who run banks in the UK should be accountable to professional standards, just like doctors and lawyers. Three-quarters of those surveyed also believed that bank staff should be qualified and regularly reviewed. 65% agreed that there is a widespread problem of ethics in the banking industry in Britain, with a further 30% who are unsure - 95% doubting the ethics in the industry. I find that breath-taking. Forcing bankers to meet professional standards, in that survey, is one of the top three actions that the respondents called for in terms of helping the banking industry.
These responses demonstrate a focus on culture and how banking is done and an explicit call for professional bankers – that is the third leg of the stool. This has to do with more than just “tone at the top” and that is why we are developing our professional standards. We hope that the work of the PSB will unequivocally demonstrate the banking industry’s commitment to ethical professionalism. This initiative is having a significant impact, not least because the plans for the PSB have been endorsed at the highest level in our member banks – Group Chairman, Group Chief Executive – and not in a parallel universe, but by interpolating this work into the core of their own codes of responsibility, their own training, their own performance systems. This is not a nice thing to do – it is the way things are done. It has become part of the culture of the organisation.
So how will we know that this approach is having an impact, apart from the fact that I think it will take a while to be able see that and judge it, or, to your challenge, how will we know that the financial system is working properly?
One way we will know is when it is more trusted and we can measure that trust. I think we became enamoured of recognising progress by measurement, probably in the Victorian era. That love affair with metrics continues today, and even though Private Fraser might say, “It is all doomed,” because we are not done with it yet, we keep re-inventing it, but it is there. And we can measure pride and professionalism and confidence and trust. We can measure values and not just outputs. The key challenge, however, is to understand the impact of those values on the business because they are not sitting out there in a parallel universe, and then metricise that impact, drawing it into the financial picture that we paint of a company.
Let me give an example, another story of sorts, where values have been taken into the heart of the business. This comes from a different industry altogether – retailing, specifically supermarkets. We know they experienced some challenges last year, just about a year ago, with the horsemeat scandal. Now, that scandal was not necessarily a matter of grocers intentionally cutting costs or taking shortcuts or not caring. Rather, it, in some part, reflected varying approaches to sourcing food, to working with suppliers.
I recently joined the Board of Sainsbury’s, which has not had any horsemeat in its products at all, and we think this is down in part to their inherent corporate practices, pulled together in a programme called the 20 by 20 Sustainability Plan. Like so many companies, Sainsbury’s has clearly defined corporate values – 20 by 20 brings those to life by ensuring that they are reflected in the way the company does business throughout the organisation, at a granular level, not simply in parallel to the core of the business.
By way of example, Sainsbury’s looks for long-term relationships with their suppliers - this is critical to their expectations for quality and value. They visit the suppliers themselves, something not all grocers do. They help their suppliers up their own game in husbandry, in production, in environmental impact. For instance, they encourage dairy farmers to learn best practice from each other, leading to a better product at lower cost, and then Sainsbury’s contract on a multi-year basis, which smoothes a farmer’s variable costs of feed and fuel and fertiliser. Sainsbury’s pays not just for past compliance but for the promise of future improvement, and all of this has positive impact on the environment, on welfare standards, on health and on the local economy. That is part of their corporate values. But, as I have said, this approach is not done as a sideline. By putting this approach at the core of the business, Sainsbury’s creates value for its suppliers, it creates value for its customers, and ultimately therefore for itself, and not just in the future but today. Social good and commercial gain are intertwined; future value translated into value today is integral to the culture at that company.
And of course, the opposite would be true: future deficits create financial risks today. Some of you are indeed working at metricising future risks that may derive from today’s operational or strategic imperatives. I know some of you will be familiar with the work that has been done to benchmark, for instance – although “benchmark” is a word we must not use anymore, but I will use it – to benchmark carbon risk in businesses. So, if you take the airline industry, you can take every airline, put it at the bottom of a graph, and we all know every company has to reduce its carbon footprint, reduce carbon emissions. Some are really at work very actively right now; others are putting that off for a rainy day – they have not really got started. So, you can look at the airline industry, airline by airline, and you can see that some are well on their way to meeting the targets they have, and others have not really got started, even though they might be doing quite well financially right now, but they are building up a huge problem and a huge expense down the line when they get closer to their deadlines, and that is a way of looking at future risk and bringing it into today’s perspective. I think that approach, for me, is a little bit of what Long Finance is about and something that we need to apply in the banking world as well.
The idea that, on the back of legislated risk, something that is hard-baked into today’s plans, we need to see what progress we are making to achieving that. I am not sure we do that in banking to the extent that we should.
So, let me close the circle by returning to banking, with the question “What can we hard-bake into expectations that will have a similar impact and, very importantly, an impact on those who judge us?” To answer that question, I think you have to start by asking: what is the purpose of banking? If the answer is something like banks are there to help people and businesses keep their money safe, help them derive enhanced value from their money and other assets, helping them to create wealth, then we probably conclude that trust is indeed fundamental to the industry. I believe we should be judged on the extent to which we are trusted today as a business, because if we are not succeeding in engendering trust today, there is every likelihood that we are building up a big expense for ourselves tomorrow.
How does trust develop? Keeping in mind that trust has to be bestowed by others, we cannot train for it, we cannot just put it in a business case, we cannot regulate it, what are the things that we can do? What are the surrogates that will show we are making progress towards being more trusted by customers or by society in general? These surrogates may well be around professionalism, around behaviours. The excellent report that came out late last year, under the banner of Long Finance and CC and BSI, explores how to make a voluntary standards market work for financial services regulation. The standards we are launching through the Professional Standards Board, as with standards that may develop from the Lambert Review, are all, as I say, voluntary. Standards call for conformity to stated norms, and that conformity can be measured. Less conformity today, perhaps we have a bigger issue tomorrow. If we are not spending today on those things that will ensure professionalism amongst our colleagues, then we are banking a big and costly problem for the future, and when investors and others judge us, should they not also judge us on the extent to which we are fulfilling our purpose, that we are meeting the expectations of the public, indeed the extent to which we even understand those expectations.
I am convinced of that and have started thinking of other things beyond trust in the industry or pride in the role, other risks, other potential fissures or stresses in the future that we could measure today that will see us right for the future. So - this is really out of left-field – I wonder about financial literacy, not whether there are social programmes in a parallel world to enhance financial literacy because we write a cheque and we do something about it, but whether the general population is or is not becoming more financially literate. If they are, they will use our products and services more wisely, we will meet their needs more effectively, we will have a more sustainable, less volatile future. If literacy declines, then the opposite may accrue and we need to address the issue.
Are there other measures of society that would ensure that we are healthy tomorrow, ensure the banking industry is indeed sustainable? If we pull up the gates around recent performance metrics, just on their own, and we make comparisons and judgements only in the abstract, we will not support a sustainable industry in the future. It is odd when things go well, we describe it in numbers and we all nod and we accept that. When things go badly, we blame behaviours. So, yes, we have to measure, I am a big believer, we are what we measure, and we have to measure both – we have to measure the financials, the numbers, and we have to look at those behaviours and find ways to metricise, to measure that, as well.
If our purpose is societal, then we have to measure what society thinks. We must not forget the purpose of banking. We must not forget that a sound bank has good financials, an appropriate “tone at the top” and, the third leg of the stool, the right culture. If we embrace that perspective and, alongside the measurement, maintain a place as well for judgement and anecdote, so we do not lose sight of the human aspects of the business, maintain a place for the stories, if you will, then we may well find ourselves in a new world, and a good one altogether.
Thank you very much.
© Lady Susan Rice CBE, 2014