In the wake of the Wells Fargo scandal, a whole host of industry stakeholders and observers have tried to piece together a solution to banking's culture problem. Yet before we settle on what banks' culture should be, we are still lacking a clear definition of what banking's culture is today.
For any culture, I suggest a simple definition: culture consists of rules imposed on and obeyed by a group. In effect, any animal that is part of a group has a culture. The rules of culture may be imposed by members within the group (e.g., professional groups or others whose members have something in common) or imposed by members outside the group, such as legal rules on banks and their activities imposed by Congress and regulators.
We are all subject to group cultures, from families to schools to businesses where we work or universities where we study or teach. In fact, a culture is very similar to a legal system. It has rule givers and rules police that watch for violations of the rules and seek to prevent violations before they occur.
But one complexity for today's large banks is they are huge conglomerates made up of different entities with competing missions and therefore competing cultures. Devising a prudent culture that works for the organization as a whole is challenged from the start.
To back up, I believe the seeds of banks' current culture issues were planted with the 1929 stock market crash. As a result of the crash, banks faced severe restrictions on many financial intermediation activities. The discrepancy between short-term obligations (deposits) and long-term lending presented a problem that was resolved by regulation: banks had to keep a backup for an eventual demand by depositors that would exceed the cash they had (which was not lent) as well as a steadier depositor base because the bank obligations to repay deposits were backed by government guarantee. Banks' ability to raise funds from investors was also limited.
But as traditional intermediation waned, other business models took hold, including those that contributed to the 2008 financial crisis. In the years leading up to the crisis, banks were given more latitude to engage in financial transactions by issuing securities to the public through their bank holding companies.
Bank holding companies issue securities to the markets for investors who expect returns. Thus, bank holding companies are under continuous pressure to produce profits. This pressure drives banks to take risks with other people's money, such as lending risks and brokerage risks, to expand methods for making profits. Bank holding companies are financial malls. They have subsidiaries that are engaged in a variety of financial services, including advisory services that must guard against the risk of breaching fiduciary duty.
Here is the other conflict for banks, which I believe has an inevitable influence on their culture problems. While a bank's obligations to depositors are contractual, backed by the government assurance, obligations to advisees, mutual funds and other beneficiaries of bank services are of the fiduciary kind. The government does not guarantee these obligations as it does the depositors. So bank holding companies now hold subsidiaries that hold other people's money under different obligations (contract, fiduciary) and different legal regimes. As a result, we see different cultures.
A borrower faces a different culture within a bank than a consumer of the bank's advisory services. Bank holding companies fill many different roles: debtor, creditor, fiduciary, issuer of securities and brokerage, among others. The laws are enforced by different regulators imposed by different duties to protect different parties.
On one hand, a bank may act as fiduciary for one set of customers, but on the other its culture is to produce money for investors and whose obligations are at least partially backed by the government.
What does the management of a bank do to manage these competing cultures? I believe the more pressing, and overriding, concern for the financial institution is to make money. Bank regulators, focused on safety and soundness and the health of the FDIC insurance fund, also want the bank to make money. So either directly or indirectly, management, employees and regulators are all focused on quarterly returns.
So are we then surprised that the banks, their managers and employees try so hard — perhaps too hard — to make more money?
What happens to bank culture under these legal structures? Bank employees are pressured to produce more profits and the pressures are laced with promises of bonuses and/or threatened termination of employment. This creates great danger of personnel engaging in unethical or even illegal activities. This pressure is only intensified if the bank's leaders are rewarded for short-term profits. Management is the model, which the employees follow. A bank's culture is linked to the culture of the entire financial system — which translates today to the mantra: Profits matter above all.
If this is our banking system, it need not be so. Here are some suggestions for bringing about positive changes in banking culture.
First, banks should be viewed as fiduciaries, the way they are in Israel and Japan. That would create a different self-image, which might lead to more honest behavior. Fiduciary status is a constant reminder that "this is not your money."
Second, servicing clients should be the No. 1 activity for the bank. Committing to providing service to depositors and advisory clients — regardless of wealth — would prompt customers to bring in other business by word of mouth. Put competition among banks in the hands of the depositors. Reputation can be built if bank employees have the pride and satisfaction that comes with rededicating themselves to service.
Lastly, while banks are beset by competing cultures, trying to combine the various interests into a single mindset is not the answer either. The solution may be to allow divisions, and to let each culture exist — and prosper — distinctly. Cultures on which various financial services are based cannot be managed — let alone controlled. Brokerage culture differs from lending culture, especially if the brokers are not paid an adequate salary. Both differ from asset management. The ghost of the Glass-Steagall Act is beckoning to us to learn from mistakes and return to clarity and a separation between banking activities.
Tamar Frankel is a law professor and Michaels research scholar at Boston University School of Law. She is author of "Trust and Honesty: America's Business Culture at a Crossroad."