Ethics and Finance: The Unresolved Puzzle

Abstract

This chapter moves from recent critiques of mainstream finance and provides an excursus on the role of ethics in finance. By underlining how several scholars have questioned the essence of neoclassical approaches based on rational behaviors and profit maximization, the chapter focuses on the emerging role of alternative approaches and on the themes of social finance and social banking.

Appendix 2.1: Banking on Value—The Case of Triodos Bank and Charity Bank

This section provides an overview of two social banks: Triodos Bank and Charity Bank. These cases are analyzed to highlight the main characteristics of social banks and of these two banks in particular.

The selection of cases is not random but rather follows an information-oriented selection approach (Flyvbjerg 2006). The cases are selected so that they are relatively similar in regard to the matter for analysis. This selection process highlighted Charity Bank in the United Kingdom and Triodos Bank based in the Netherlands as two very interesting cases. In particular, they provide extensive information about their impact measurement and reporting approaches.

2.1.1 The Case of Triodos Bank

Triodos Bank is a European social bank registered in the Netherlands, and since the 1980s, it has distinguished itself by specializing in financing innovative environmental and social enterprise initiatives with social and environmental aims (Cowton and Thompson 2001; De Clerck 2009; Dossa and Kaeufer 2014; Bouma et al. 2017). Triodos Bank had tried to position itself as a humanistic alternative to other banks to demonstrate that saving, investing, and lending can be combined with social and environmental progress (de Graaf 2012, p. 159). Many authors consider Triodos to be an excellent example of the European tradition of “social banking”, which has evolved to meet the particular needs of the social economy that often face difficulties in obtaining finance from the traditional providers (Weber and Remer 2011; Cowton and Thompson 2001) by trying to restore a sense of relationship between depositors and borrowers which tends to be broken in conventional banking practice (Cowton 2002; Cowton and Thompson 2001). The Triodos website states:

Triodos Bank was founded on sustainable principles, so sustainability is in our DNA. For us, sustainable banking means using money to bring about positive and lasting change; placing value on people and planet, as well as profit. We do that by financing companies, institutions and projects that add cultural value and benefit people and the environment, with the support of savers and investors who want to help make the world a better place – as well as a good return on their money. Crucially, our definition of sustainable banking means that this is all we do: we only invest in sustainable enterprises and we only use the money entrusted to us by savers and investors – just like banks used to do, in the days before derivatives and credit default swaps.

Triodos Bank’s mission can be summarized as follows:

• To help create a society that promotes people’s quality of life and that has human dignity at its core;

• to enable individuals, institutions, and businesses to use money more consciously in ways that benefit people and the environment and promote sustainable development; and

• to offer customers sustainable financial products and high-quality service (Triodos Bank Annual report 2016, 2017, p. 1).

2.1.1.1 Risk, Return, and Impact: The Triodos Approach

Triodos’ business approach focuses on delivering sustainable social, environmental, and cultural impacts as well as risks and returns via the following business principles:

• Promoting sustainable development—considering the social, environmental, and financial impacts of everything we do;

• respecting and obeying the law—in every country where we do business;

• respecting human rights—of individuals, and within different societies and cultures; supporting the aims of the United Nation’s Universal Declaration of Human Rights;

• respecting the environment—doing all we can to create and encourage positive environmental impacts;

• being accountable to all our stakeholders for all our actions; and

• continuous improvement—always looking for better ways of doing things in every area of our business (Triodos Bank Business Principles 2016b, p. 1)

Unlike traditional banks, which primarily focus on risks and returns to avoid negative outcomes and maximize returns to shareholders, Triodos Bank uses impact, risk, and return from a long-term perspective (Triodos Bank Annual Report 2015, 2016a). Triodos’ investment strategy revolves around six main sectors:

• Energy and climate

• Emerging markets

• Inclusive finance

• Sustainable food and agriculture

• Arts and culture

• Sustainable real estate

• Socially responsible investments

Triodos Investment Management⁸ also invests in listed companies with above-average environmental, social, and governance (ESG) performance.

2.1.1.2 Risk Management

The aim of Triodos Bank’s risk management activities is to ensure the long-term resilience of the business (Triodos Bank Annual Report 2016, 2017). Its risk appetite is based on three objectives that complement its goals and guarantee a sustainable banking model. They are to (1) protect the bank’s identity and reputation, (2) maintain healthy balance sheet relations, and (3) maintain stable growth. A risk governance framework and a three-line defense model have been put in place. The three lines of defense model involves

• first-line functions: responsible for managing the risks of operations;

• second-line functions: ensure that risks are appropriately identified and managed; and

• the third line of defense: (the internal audit function) provides independent and objective assurance of Triodos Bank’s corporate governance, internal controls, compliance and risk management systems.

The director of risk and compliance is fully responsible for second-line risk management and compliance activities and reports directly to the chief financial officer. Such activities are supervised by the Audit and Risk Committee of the Supervisory Board.

2.1.1.3 Impact

Under the Global Alliance for Banking on Value (GABV),⁹ Triodos Bank has developed an impact scorecard that is designed to measure

• basic requirements of a sustainable bank such as its mission and approach to transparency;

• quantitative factors, such as the proportion of the bank’s assets committed to the real economy; and

• qualitative elements that provide an account of how a bank translates its sustainability agenda into its actual work.

2.1.1.4 Return

In recent years, Triodos Bank has faced stiff competition from conventional banks showing a growing interest in sustainability as a market opportunity. Despite this, Triodos continued to grow its sustainable loan portfolio by 13% in 2015. Its total loan portfolio, which includes short-term lending to municipalities, increased by 22% while its assets under management grew by 19% in 2015 (Triodos Bank Annual Report 2016, 2017).

2.1.2 The Case of Charity Bank

Charity Bank was founded in 2002 to support charities and social enterprises with loans and to provide people with opportunities to save in line with their values (Charity Bank 2017/2018 Loans Portfolio Report 2017a). Charity Bank was founded with the charitable mission to lend money to charities and social enterprises, and it was the first charity to be granted a banking license from the Financial Services Authority, rendering it unique as the only not-for-profit bank lending exclusively to charities (Buttle 2008). Shareholders are led by Big Society Capital and the Charities Aid Foundation and include a number of charitable trusts and foundations (Charity Bank Annual Report 2016, 2017b) that are committed to supporting the social sector. Charity Bank’s balance sheet increased by 15.3% during 2016, while on the assets side, loans to charities, community groups, and social enterprises increased by 27.9%, with 72.8% of the balance sheet being used to make charitable loans. With respect to liabilities, deposit levels increased over the years, growing by 12.9% in 2016 (Charity Bank Annual Report 2016, 2017b). Charity Bank’s principal risks and uncertainties lie in its exposure to

• the political and economic environment and changes in the government’s approach to social policy;

• credit risk and the concentration of such exposure in one sector, with a resulting lack of portfolio diversification;

• a mismatch between the tenor of its loans and the maturity of its deposits and the risk of depositors withdrawing deposits upon notice (“liquidity risk”);

• interest rate mismatches on its assets and liabilities;

• funding risk and particularly the need to fund increases in the loan book via capital raising and deposits from savers; and

• key person dependencies arising from its small size (Charity Bank Annual Report 2016, 2017b).

2.1.2.1 Social Impact Assessment

Charity Bank seeks both social and financial returns and has systems and processes to ensure that its decision-making processes help it achieve both (Charity Bank Social Impact Statement 2017e). The bank assesses the social impacts of the organizations to which it lends by considering how the organization will benefit of the loan and how the people it is working with will benefit of the loan (Charity Bank Measuring our social impact 2017d). In doing this, the bank considers three areas that are most relevant to its borrowers:

• Mission focus—Does the organization have a clear idea of what it is trying to achieve?

• Organizational capacity—Does the organization have people with the right expertise and sound systems of governance?

• Financial resources—Does the organization have the finances necessary to service the loan and meet its business plan objectives? (Charity Bank Social Impact Statement 2017e).

Table 2.1 presents an overview of sectors through which Charity Bank grants loans.

Table 2.1 Charity Bank: Loans per sector since 2002

Loans are granted to the following types of organizations:

• Loans for any purpose and on any terms to any entity that is itself a charity and provides a public benefit;

• loans for any purpose and on any terms to any entity that meets Charity Bank’s criteria as a social sector organization;

• loans on a mixed-motive basis where there is more than an incidental noncharitable (or private) benefit; and

• loans to other organizations without a charitable purpose and that are not social sector organizations under circumstances where the potential borrower can adequately demonstrate to Charity Bank that

  • the loan, if drawn, will facilitate material worthwhile social impact that could not otherwise be achieved or is a refinancing of such a loan;

  • the borrower passes Charity Bank’s due diligence process; and

  • the loan documentation incorporates protections to maintain the organization’s commitment to its intended social impacts or requires Charity Bank to be prepaid if it ceases to maintain its stance on supporting social impacts (Charity Bank CSR Policy 2017c).

2.1.3 Looking for Similarities and Differences

Although both Charity Bank and Triodos Bank can be classified as social banks, they have different characteristics and mission statements. Triodos Bank delivers retail banking services (e.g., payment cards) in addition to loans and investment funds, while Charity Bank delivers savings accounts and loans to charities while actively excluding loans made to for-profit enterprises. This is a crucial difference and implies that Charity Bank will refuse certain projects that may be accepted by Triodos Bank. Table 2.2 highlights the main differences in terms of mission statements and impact assessments.

Table 2.2 Mission statements and impact assessments of Charity Bank and Triodos Bank

Despite their many differences, Triodos Bank and Charity Bank have a common claim of contributing to positive social and environmental outcomes. Transparency is a strong value attached to their business activities. Both banks provide information on specific projects that they lend to through storytelling.