Ethics and Financial Crime: Interrelationship

April 25, 2020

Ethical Culture and Financial Crime in Banks: Interrelationship

(Published in the Financial Express in 2018)

Dr. Shah Md Ahsan Habib[1]

Banking industries in both developed and developing economies have been coming across surges either of financial crimes that are generally realized by banks’ own workforces, or by customers or by external forces or by their combinations. Practically, all key stakeholders like Board, employees, clients, external organized crime groups or influential sections and those with whom banks have business dealings might be engaged in such crimes. Today, offenders are more sophisticated than ever and criminals continuously probe banking organizations’ defenses through innovative techniques. Alongside big banks, small banks are easy prey for criminals, as many lack robust systems to fend off threats. Given the dynamism in the approach of financial crimes, it became a critical challenge for banks to catch up with the development. If the perpetrators get advantage of deficiency in bank management in terms of ethical corporate practices and culture, the risks become even higher. Employees should have very limited incentive and fortitude to undertake unethical practices in an environment with integrity and strong ethical culture. This is particularly essential in a banking environment where the agents manage assets and representatives of a small section of financial contributors guide and influence management decisions. In recent time, the essence of creating ethical environment is lauded globally as a measure to address financial crime in banking industry. Though ethical practices has always came up as one of the crucial factors to address fraudulent activities,  but probably for the first time, the stakeholders are associating financial frauds and crimes with the unethical behaviors of banks and raising voice so strongly to work for improving corporate ethical practices in banks.

Unethical activities violate the moral standards of society and might be with the customers, with the colleagues, and with other stakeholders. Unethical behavior towards colleagues involves behaviors such as sexual harassment, discrimination, not respecting employees’ privacy, or violating wage, overtime or benefit rules. Unethical behavior towards the organization as such includes behaviors like stealing or misappropriating assets, misusing confidential or proprietary information, or falsifying/ manipulating financial reporting information. However, the line between ethical and unethical behavior is not always easy to draw, and the task is even more difficult if we take into account the differences in moral standards between societies and cultures. It is very crucial to understand, under what circumstances unethical behavior at the workplace is more likely to occur. Usually one would think that unethical behavior occurs because there are people with low morals who see an opportunity due to a lack of proper internal controls. However, the published research activities have shown that the possibilities of unethical behavior at the workplace is influenced by two critical factors- employees’ work relations and colleagues’ behavior.

Global evidences reveal that the frequency of unethical behavior at the workplace is increasing. The Association of Certified Fraud Examiners (ACFE) regularly publishes reports about occupational fraud and abuse; the recent report noted, a typical organization loses 5percent of its revenues to fraud each year; most occupational fraudsters are first-time offenders; the victim organizations decided not to refer their fraud cases to law enforcement, with fear of bad publicity being the most-cited reason; over 8 percent of the victim organizations were fined as a result of the fraud. Unfortunately, only a small fraction of cases of unethical behavior eventually are brought to (criminal) court;  and many incidents are probably never detected, or at least not detected officially by a person in charge of addressing and investigating unethical behavior.

In the context of banks, ethics are commonly conceptualized by trust, efficiency, openness, transparency and accountability, development and community involvement. Cooperative behavior promotes trust. Morals in banking operations require integrity on the part of owners and directors, senior management as well as junior officers dealing directly with depositors and borrowers. Accordingly, integrity in banking operations requires integrity on the part of owners and directors, senior management as well as junior officers dealing directly with depositors and borrowers. 

It is recognized that trust and morals in banking is clearly linked to the ethical practices. Codes of ethics have been one of the primary policy responses to large scale acts of corporate crime. In the context of banks, ethical standards may be expressed in a company’s formal conduct requirements, or contained in generally stated principles that guide a company’s preferred conduct or behavior. In Banking Industry, code-of-ethics is implemented for employees and as a whole for the bank management. For the Management, Standards and ethical codes in banking industry are commonly directed by the regulator through fair practice code covering taking care of the interest of stakeholders, disclosures and customers right. It is important to have ethical behavior in governance which goes far beyond company law or banking laws.

There are evidences that financial crime or scams in banks and financial institutions are on rise, and many of these are associated with ethical behavior and culture. The shapes and forms of financial crime threats as well as their degree of severity have transformed over the years, partly due to the increasingly globalized/borderless financial systems coupled with new technologies. The financial crimes can be segregated into different forms from different dimensions. Financial scams are amongst the common news in the media. Media reports and surveys have been coming up with the information of innovative scams regularly. Financial scams and crimes are becoming so common that news of email scams, online scams, invoice fraud, cheque and bank draft scams, identify theft etc. do not surprise us. In the context of a number of banking sectors of developing countries, high percentage of non-performing loans has been amongst the key concerns and some of these are clearly the case of asset misappropriation. Though not always, in many instances these are the outcomes of financial frauds or crimes. Sometimes, it is not easy to identify the willful defaulters from the defaulters with genuine reasons. Thus, in most instances, the stakeholders do not term these as financial crimes, and generally willful default is not regarded as a criminal offence. However, the situation is changing now, and there are growing demands to term willful default as a criminal act; and several efforts are on to frame stringent regulation to handle this financial crime to save banking and financial sector.  In regard to the interrelations of ethics and financial crime in banks, ethics is related to all types of crimes in banks and financial crimes are clear examples of ethical lapses, but all ethical lapses are not crimes. The current state of banking ethics, the enormous size of banks and the banks’ inability to detect real-time fraud all contribute to the ongoing failures in preventing serious banking crimes. The president of New York Fed, William Dudley, in 2013, acknowledged that ‘the deep-seated cultural and ethical failures at many large financial institutions’ had been a result of the growing size and complexity of banking structures, as well as a result of bad incentives. Some recent banking scandals underscores why a structural reform of the banking system is urgently needed and corporate ethics should get due emphasis.

[1] Professor and Director (Training), BIBM ([email protected]).

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