Chairman Howard Davies looks at rebuilding trust in banks
Chairman Howard Davies gave the annual lecture at the Harkness Fellows Association yesterday, entitled: “The City after the crisis and Brexit: will bankers ever be respected again?”. Read the full lecture here.
28 November 2019
“The Harkness fellowship was a life-changing experience for me. I used it to take the Sloan Programme at Stanford Business School in 1979-80. Some of what I learned then has remained relevant for 40 years.
After Stanford I returned to the Treasury, where I gloried in the title of ‘Principal, Monetary Policy’, which meant I took the minutes at meetings with the Bank of England. At that time, interest rates were set by the Chancellor, after listening, or not, to the Governor. It was the start of a long association with the financial sector, which I have observed from a number of different perspectives in the Treasury, the Bank of England, the FSA (may it Rest in Peace) Morgan Stanley and now RBS and the Prudential.
The City’s reputation has waxed and waned during that period. For a long time politicians of all colours, whether they instinctively sympathised with the world of finance or not, regarded it as a goose that laid golden eggs, and it was very important in the national interest not to say ‘boo’ to it for fear it would fly off elsewhere, and roost in Frankfurt or New York. In my valedictory letter to the Chancellor, Gordon Brown, in 2003 I noted that whenever the FSA had taken decisions which affected the interests of large firms, their leaders has been received by Ministers who often passed on their complaint that we were behaving ‘un-commercially.’ I argued that investment banks and hedge funds had too much influence on the government.
That all changed after 2008, when the goose left a rather nasty mess on the carpet, rather than ‘a golden egg’. Finance does not sit so proud today. Witness the Brexit negotiations. More political capital has been expended on the interests of the fishing industry than on the financial sector. There is only the most fleeting reference to finance in the Political Declaration, and hopes of a deal which would allow City firms to continue to ‘passport’ into the rest of the EU have been dashed. From the City’s point of view all the Brexits currently on offer are at the harder end of the spectrum.
The reasons for this fall from grace are not hard to find. The financial crisis of 2007-8 dealt a severe blow to the reputation of the financial sector. The Masters of the Universe were revealed to have feet of clay. The story has been told many times, though consensus about the underlying causes remains elusive. In my own course on the subject, which I teach at Sciences Po in Paris, I distinguish between the state of the roads, and the conduct of the drivers.
In other words, in the years before 2007 leverage had been allowed to grow dangerously, driven by global imbalances which resulted in a liquidity glut in Western countries. These bubble-like conditions were made even more dangerous by monetary policy, especially in the US, which appeared to deviate from previous patterns. Rates were for a crucial period below what would have been implied by the Taylor rule.
But none of that excuses the reckless behaviour of the drivers – those who ran major financial institutions - who appeared to think it was safe, in these conditions, to keep their feet on the floor.
Many of the trading practices were reckless, and some, shall we say, lacked integrity. In several countries the state had to step in and mount expensive rescues. In many cases the costs have since been recouped, though not in the case of RBS, where the government remains a 62 per cent shareholder and is highly unlikely to get all its money back. I explained why that is so in a lecture at King’s College London in September last year, for those who are interested.
Quite apart from the losses on unwise credit extension, the costs of various forms of misconduct, for banks as a whole, have been huge. Mark Carney’s estimate is that, globally, banks’ misconduct costs have reached over $320 billion, capital that could otherwise have supported up to $5 trillion of lending to households and business. In the UK, mis-selling of Payment Protection Insurance alone has cost the banks over £50 billion to put right.
The consequences of the debacle are still with us today. In most of Europe the economy is some 10-12 per cent smaller than it would have been had pre-crisis trends continued. Government debt to GDP ratios are substantially higher, here and elsewhere. Wages stagnated interest rates are historically low and central banks struggle to reach their inflation targets. Investment demand is weak. It is arguable that the growth of populist parties in Europe is also, at least in part, traceable to the impact of the crisis. The share of vote achieved by such parties grew sharply in the election after the collapse of Lehman Brothers and has continued to rise.
Furthermore, and this takes me to the central topic for tonight, the reputations of the elites, financial, economic and political, were damaged. Michael Gove famously picked up on that new mood when he said in the EU referendum campaign that Britons ‘have had enough of experts.’ That applied more to economists than to bankers, at the time, but the two are intertwined in the popular mind, even perhaps in the Royal mind. The famous ‘Queen’s question’ about the crisis ‘how come nobody could foresee it?’, was an excellent one. As it happens I was one of two LSE people who heard it – the other being Professor Luis Garicano, now the leader of the Spanish Ciudadaňos group in the European Parliament. We did not have a good answer then, and the British Academy, which convened a highly eminent group to address it, did not produce a very succinct one either.
But Michael Gove may or may not have been speaking for the population as a whole. What can we learn from broader surveys of opinion? Is it true that bankers, and other finance sector leaders, have lost respect and trust as a result of the crisis and their other crimes and misdemeanours? If so, does it matter? And if so, what can be done about it?
You will detect that if the answer to the first question is ‘no’ this will be a very short lecture. Maybe that is what you are hoping. But I am here to disappoint you.
There are a number of sources which measure trust and reputation, in financial services and in society more broadly. They include the National Centre for Social Research, The British Social Attitudes Survey, Ipsos Mori, Edelman, Accenture and a variety of internal bank surveys. They are not always entirely consistent, sometimes because the questions are slightly different. But broadly they tell a similar story. I will pick and mix a little between them as I proceed.
So to go to my first question, did the crisis damage trust in banks? The answer is an unequivocal yes. The British Social Attitudes Survey asks a question about whether people think institutions are ‘well run.’ On that measure, over the last 40 years almost all institutions have declined. The police fell from 77 per cent in 1983 to 65 per cent in 2012, the BBC similarly, and ‘the press’ halved from 53 to 27 percent. But banks suffered the most precipitous fall, from 90 per cent in 1983 – at that time well above the NHS, to only 19 per cent in 2012. What a falling off was there.
But this survey is rather a blunt instrument. It does not allow one to disentangle the different elements of trust, nor does it give any comparisons with other types of industry, and it is purely national.
The Edelman ‘Trust in Financial Services’ reports help unpick the story a little.
The Edelman figures confirm that trust did fall sharply after the crisis, but also that it has recovered quite significantly since then. Over the last five years, on their measure, trust in financial services has gone up from 49 to 57 per cent, and has improved more rapidly than in other sectors. Still a little behind sectors like technology firms, but not so far.
The Edelman numbers show two other things, which are rather interesting.
First, on the trust in financial services measure the UK is about in the middle of the pack internationally. China is top of the league at 83 per cent. I am not entirely sure what that means. The big banks are still largely state-owned. Singapore is at 68 and the US at 58. But we are well above France, Italy and Spain, with Germany at the bottom with a score of 38. The problems of Deutsche Bank may be creating a reverse halo effect. Yougov finds a similar ranking, though with Italy and France slightly below Germany.
But second, the Edelman index distinguishes between the views of people they describe as ‘informed’, which means with a degree and regular consumption of the media, and the rest. Among the informed public the UK is about the same as the US, applicably higher up the table, while the mass population number is far lower. There is a 12 point gap between the informed and the rest, a gap which is both much bigger then it used to be, and much bigger than in other centres.
So, in the UK, trust in banks and other financial companies has recovered to a great extent among those more highly educated, but less so among the rest. That is in fact a general phenomenon in the UK. There is a broader barometer of trust in business, NGOs and government. Those figures were remarkably similar to those for banks, and, again, the gap between the informed and the rest is unusually large. It is a 24 point gap in the UK and only 13 points in the US. There is clearly a sense among ordinary people in this country that ‘the system’ is not working for them.
It appears that we have a uniquely large degree of alienation between the mass of the population and the institutions with which they interact. Very recent figures from Britain Thinks show that 82% of people do not think that political leaders understand the lives of people like me. The figure for business leaders is a mere 66%. Banks are part of that picture, but do not appear to be significant outliers.
That is not to say that we should sit back and accept there is nothing we can do. Our banks’ reputation with customers is not where it should be, or indeed where it has been in the not too distant past.
An Ipos Mori survey tells us a little more about what is going on. They usefully break trust into three component parts:
1. Basic trust: is the bank good at what it does and reliable?
2. Active trust: is the bank well lead, responsible and transparent?
3. Interactive trust: does the bank act with my interests in mind, or would it try to take advantage of me if it could?
Broadly, banks get fairly positive scores on Basic trust. People do recognise that their accounts generally work quite well and that we do not lose their money very often. The Active trust measures are more mixed. There is a positive score on the ‘well led’ matrix – something with which of course as a Chairman, I strongly agree, but people do not think we are transparent enough. There is a rough balance between supporters and detractors on the ‘responsible’ question. On Basic and Active trust, banks are about on a par with supermarkets, and well above insurance companies and independent financial advisors. So not too bad. It is, however, on the Interactive trust indicators where we fall down. In particular, 52 per cent of people think that their bank ‘would try to take advantage of me if it could’ and only 17 per cent disagree. So the ‘I am your banker. I am here to help’ line does not go down too well.
Is the position getting better? There is a long time series available from Ipos Mori on the question ‘who do you trust to tell the truth?’. Over the last seven years the score for banks has risen from 29 to 41 per cent - above journalists (of course) and just below trade union officials. Doctors and nurses top the poll. Intriguingly, the fastest risers over recent decades have been civil servants, while the biggest fallers have been the Clergy. Make of that what you will.
One peculiar dimension of their trust index is the differential between people with decided views on other issues. Perhaps it is not a surprise that Conservative voters are somewhat more inclined to trust banks then are Labour voters, but it is also the case that Leave voters are more well-disposed towards bankers than are Remain voters. I do not have a well-developed hypothesis to explain that.
So the conclusion I would draw is that banks have made some headway in restoring their reputation for competence, after a very bad period, but have not convinced their customers that they are acting in their best interests, or that they have fully rectified the ethical and cultural flaws which contributed to the PPI, Libor and FX scandals.
Does that matter? Again I would answer yes to that question, for two reasons.
First, because if people are suspicious of banks and other financial services companies they may make sub-optimal decisions about their finances. Frankly, it is hard to prove this contention with any certainty, but Andy Haldane of the Bank of England has argued that trust “leads people to retreat from the stock market and banks and more towards cash holdings and informal sources of credit” “which “potentially hobbles both economic growth and financial stability.”
As a matter of principle, that argument is appealing. But I am not sure we can demonstrate that depositors have moved money out of banks and under their mattresses. There is the extreme case of the run on Northern Rock, of course, but even there the funds were generally moved into other banks.
The second area of concern is linked, but it may be thought to be more self-serving from a bank perspective. A distrusted banking sector may be more vulnerable to new competitors. There is some evidence that Fintech companies, especially neo-banks like Monzo and Revolut in the retail market, and Starling and Tide which target small businesses, are making inroads into the traditional banking markets. Some of them have clearly learnt lessons from the trust analysis I described. As Paul Stamper of Ipsos Mori has said, these ‘providers are introducing offer approaches which could enable financial services brands to establish both active and interactive trust, involving customers in decisions about new product features or services which are beneficial to the customer and neutral or even, on the surface, detrimental to the bank, such as reducing the charges they pay.’ Consumers react well to that, as they might. Whether the business model is viable in the long run only time will tell. But some of these brands are building a reputation for trust and value for money which could be monetised in the future. The introduction of open banking, allowing customers to grant access to their financial data to non-bank service providers, has facilitated that penetration. And as well as the fintechs, big tech companies are moving into areas of past bank dominance like the payments system.
Banks can respond to these threats, and are doing so, but it is clear that if customers do not trust them, or are given poor service, they are more likely to experiment with alternative providers. A McKinsey study has shown that customers who are dissatisfied with the service they get from their mortgage provider are seven times as likely to switch to a new provider at the end of their initial mortgage term as those who are content with the service they receive.
Some of the dissatisfaction is related to clunky IT systems, and is not a question of trust or respect, but the interactive trust point - do I think the bank is acting in my interest - is highly relevant. So how do banks rebuild that form of trust?
The answer is not as simple in the case of banks as it is in other consumer-facing businesses. Martin Taylor from the Financial Policy Committee at the Bank of England put it well in a lecture three years ago:
“the customers of a bank do not stand in quite the same relation to it as the customers of a retailer or a car manufacturer… in the credit business ‘the customer is always right’ just does not apply. A customer nearing or in default cannot be said to be right… more generally, borrowers and depositors are more like counterparties of these banks than clients in the true sense.”
But Taylor points to the danger of that way of thinking if it is taken too far. Retail banking, he argues, did develop into a counterparty not a client relationship: “the relationship with the customer is highly instrumental. Buyer beware, backed up with 200 pages of small print, makes an unlikely foundation for trust.”
The ‘client as counterparty’ way of thinking is particularly inappropriate for small, unsophisticated customers, whose financial literacy is limited, and where the asymmetry of knowledge and understanding is particularly stark. That is one reason why, at RBS, our ambition has been to lead on both trust and consumer advocacy, with staff trained and managed to carry out financial health checks with customers, rather than incentivised to sell particular products. That change in emphasis takes time to have an impact, but over a period it should rebalance the relationship.
One interesting consequence of the changed approach is that employees are more energised and engaged, which is likely to be positive for the future. More of our staff now believe the bank is trying to do the right thing for customers. Indeed across the industry employee trust is higher in financial services than other sectors. 81 per cent of financial sector employees trust their employer, compared to only 73 per cent in healthcare and 68 per cent in the food and drink industry. There are a number of components of trust between employer and employees, but the latter are certainly influenced by the sense that their employer is ‘doing the right thing.’
Of course we must also ensure that we stem the flow of scandals and missteps. There are signs that has happened. While we do continue to remediate some past failings, notably in the treatment of troubled small businesses in and after the last recession, it certainly seems that the worst of the past legacy is now well behind us. For RBS and for banks overall the incidence of fines and customer remediation, apart from the long running PPI saga which is now close to completion, has fallen sharply. The recent regulatory focus has been on peer to peer lenders, bond funds offering implausible returns to small savers and doubtful fees charged by asset managers.
It would be a foolhardy Chairman who promised a clean bill of health for the future. Regulatory standards change, consumer expectations change and market conditions too, so that products and services that look entirely reasonable today may appear less than satisfactory in the future. But I do believe that the big banks have digested the uncomfortable lessons of the past and made significant changes. Regulation has given them a strong incentive to do so. Boards have new responsibilities to which regulators hold them. I am now held personally responsible for the culture of the organisation, for example. So we try to measure that culture regularly, with the help of the Banking Standards Board. We have redesigned pay systems and introduced clawback mechanisms to recover pay if customer outcomes are poor. That really does happen, and has a big impact on behaviour.
Is there more to do? Yes. Andy Haldane and Martin Taylor have both pointed to other areas where work is needed. Financial education is one of them. We and other banks spend money on it, but the totality of the effort is less than the sum of the parts. The government has been seeking to promote more co-ordination and I hope whoever is in government on 13 December will continue with that effort. Haldane also points to the need to articulate a more persuasive social purpose for banks. Our new CEO, Alison Rose, is working hard on that now and will be saying more in a strategy statement at the end of her first 100 days in mid February.
That purpose needs to demonstrate a link between what banks do and the welfare of their customers and communities. We need to talk more about that than about our own size and success. We need to show how we contribute to all parts of the country rather than just EC4.
So to conclude. The wounds from the financial crisis run deep, and not just in New York and London, its epicentres. A couple of weeks ago I was loitering in a bookshop on the Boulevard St. Germain, near where I teach. They have a collection of postcards by a French cartoonist called Voutch, not so well known over here. One shows a suited gent in an elegant high-rise office welcoming a young man. He is saying – and I will use the original French to this cultured audience, “Vous étes stupide, ambitieux et totalement irresponsible. Bienvenue au personnel de cette banque.”
I suspect that neither here, nor on the Left Bank, will we go back to prelepsarian times when sub-prime mortgage packagers were looked up to as people who had discovered a modern day version of the art of alchemy. I regard that as a good thing. Professions which wrap themselves in jargon to confuse the non-initiated are usually engaged in some form of conspiracy against the public.
But it is important for the functioning of modern economy that people, whether financially sophisticated or not, have confidence in the institutions which transmit, manage and invest their money. UK banks are on their difficult way back to respectability. We have a lot more to do, however, and are faced with the truth of the Dutch proverb “Vertrouwen komt te voet en vertrekt te paard.” It is possible that even Harkness fellows have forgotten some of their schoolboy Dutch, so I translate “Trust comes on foot, but leaves on horseback.” As I have shown, the collapse of confidence in 2008-9 was dramatic: we are on a slow trudge back to respectability.”