Linda van Goor, Regulatory Communication (The Netherlands): Can we re-humanize banking?

Discussion paper. Comments welcome using this link [1]

Where did we end up in banking? Did we really aim for this?

Resilience, agility, adaptability, the newest buzz-words in finance. News titles like “The fintech threat to traditional banking. It’s evolution, not revolution.” are scaring the living daylights out of some bankers and giving hope to others. Banking giants appeared not as resilient as many believed until only a few years ago, and what did we do? Create new legislative frameworks. All understandable, but does it help? Fintech bankers are organizing their business around the old, failing in their eyes, systems and are left with the puzzling question what rules actually apply to them. The recitals of the latest legislative revisions say it all: “Considering the devastating effects of the latest financial crisis the overall objectives of this Regulation are to encourage economically useful banking activities that serve the general interest and to discourage unsustainable financial speculation without real added value.” (recital 32 CRR). That implies activities were taking place before “without real added value”. Interesting, why did that happen? Why did anyone want that?

Or: “In light of the nature and magnitude of unexpected losses experienced by institutions during the financial and economic crisis, it is necessary to improve further the quality and harmonization of own funds that institutions are required to hold.” (recital 72 CRR). That implies that evidence was found that bankers held own funds of inferior quality (and it was indeed) and had more unexpected losses than they had perceived (and they had). Interesting, why did they do that?

Observing that “less significant banks” are financing 70% of the German economy, as recently pointed out by Sabine Lautenschläger, implies that “significant” is not defined as “important to people”. “Significant institutions” are defined as something like that their failure might seriously affect our society. Does that make sense? She also noted the contradiction of banking legislation made for a few (129 of 3,200), while “most” (3,071) don’t fit the model.

In this blog I’d like to contribute to the debate about resilience and agility in the banking sector, and advocate a renewed role for core values, determining business cultures, business models, and also regulation, closer to what may matter to “most” people: inclusive, adding real economic value, and safe. The High Level Expert Group on Sustainable Finance will start this week considering how to get to a clear set of policy measures that steers stakeholders in the financial sector towards a system that supports this world and its inhabitants over the longer term. It would be great if these wise men and women would consider human values in finance.

Human beings and market efficiency

The recent insights by behavioral economists like Daniel Kahneman (2003, 2011) and Simon Sinek (2009) are regarded revolutionary: people are socially minded creatures (Aha! That’s what it was!) and their decisions are dependent on the connections they have with other people. Not rationally, independent thinking individuals as was (usefully) applied in the century before by economic science. Not like the models economic science created to predict financial dynamics, on which business models were based, to which legislation was a response. People appear to behave differently, seemingly chaotic even, from what was predicted by models. Typically, people under stress tend to behave very different from “normally distributed” (e.g. Kandasamy a.o. 2014).

This observation matters a lot when considering what it is that people in general and bankers in particular do and how they make decisions. It matters a lot when we need to base what we do in business, and how we organize that with regulation, on common values that are recognized by all. For example, it matters a lot when thinking about “too big to fail” – at what point does an organization grow outside the boundaries of resilience, agility and adaptability? Possibly at the point where people don’t see the impact of their behavior anymore. “Market efficiency” used to be a major driver of legislation, but confining that to numbers only is far away from what is meant by “social market efficiency” and “social progress”, the European values confirmed in the European Constitution, which also includes values like human dignity, inclusion, respect and justice. Those European values, actually, make a lot of sense. When did we forget that?

With his golden circle Simon Sinek (2009) points out, that the decision making part of the brain needs the “why”, the core value driving behavior. The “why” makes loyal, and once people are appealed by the “why”, the “how” and the “what” follow easily. When people get numbers as a starting point to anchor their behavior, the aggregate result may be something that’s not controllable by human beings anymore, because the result is actually not about human beings. When people get a feel of the result they may head to, a physical reaction even, they appear to follow massively, which was for example the (disruptive!) effect of Apple’s approach and Steve Job’s famous speech in 2007 about his new i-phone.

Stephen Covey (1994) developed a useful management tool, based on a speech by President Dwight Eisenhower in 1954: a matrix distinguishing more versus less urgent and more versus less important matters. He observed that managers allocate most of their time to urgent matters, also when they’re not so important. By choosing not to allocate time to more important matters, such as what is it that I’m fundamentally doing business-wise, their situation worsens and stress hits. Covey’s point is to allocate sufficient time to important, less urgent, i.e. more fundamental, matters.

Well, by their nature, banks collect deposits which depositors can claim on a daily basis, and bankers’ role is to invest that money in projects that provide sufficient returns to live up to their promises to depositors. On top of that, many banks are blessed with owners that wish to see “good” returns on their “investment” (which is different from taking good care of their ownership), preferably visible on a daily basis, compensating the “risk they take”, and prepared to leave the bank the minute the investor (who doesn’t feel like an owner) doesn’t see that “good return” anymore. This mechanism drives bankers to act as myopic as possible (e.g. Boot 2014).

The economic rationale that justifies this mechanism is called “market efficiency”: markets know everything there is to know and process all that information into the price today, so the market price always includes also future information and is thus always “right”. If that implies that life is determined by numbers produced today, I dare to doubt whether that indeed appeals to most human beings. It implies that numbers produced today can make or break your career.

The consequence of this mechanism is that banks, like any other business led by this market-efficiency by the way, tend to focus and spend most of their time and energy on the image they have today, the reputation they have today, the perception of the value of their business today, or even, this minute. In a completely open digitalized world this is a scary thought, leading to behavior as observed by antropologist Joris Luyendijk (2015) in the London City, the “up or out” culture.

This up-or-out culture implies you take the chance today and hope you’re still in tomorrow, and excesses happen. Famous is Citigroup’s Charles Prince’s quote in July 2007 regarding the bank’s activities in CDOs in spite of fears of reduced liquidity: “As long as the music is playing, you’ve got to get up and dance.” Excesses happening on a big scale, however, lead to systemic problems, and politicians and regulators are called to “solve the problem”. It’s even explicit in the banking rules: “The objective of the CRD is to contribute to the achievement of an integrated, open, competitive, and economically efficient European financial market…” (where did the word “social” go as in the European Constitution?). Solving the problems of today appear not to change behavior, however, for that behavior was determined by the very core driver of it all, market efficiency, which was justified because prices are always right, leading to the up-or-out culture, leading to more and more complex regulations, determining operations, leading to business models based on numbers and money. Strategy in this world seems a matter of how to survive best in the short term and by all means it’s too long term oriented to think about it today; what Stephen Covey typically would call important but not urgent. In the course of the process the core human values of “social progress” “inclusion” and “solidarity” were overshouted. This is reflected in the picture, of which I sincerely hope that it exaggerates the real experience of most bankers today and as such is a worst case reflection: most energy is spent on today’s reputation, then on the up-or-out culture, then on regulation. After the survival question how the business then needs to be done done, the question why the bank does what it does, for whom, etctetera, needs to wait a bit.

What if we would assume that humans behave like natural creatures?

For a socially compelling concept that may serve us in the future, several authors took our natural environment as inspiration as to how we could not just strive for robustness, but for resilience beyond sustainability, i.e. a regenerative system. After all, nature has proven to be exceptionally self-directed and nevertheless it always strives to manage risks for individual species in just the right way.

Learning from his long experience as a business consultant, Martin Reeves (2016) observes six “laws of nature”, especially when the environment is complex and uncertain, which appear to benefit corporations as well: redundancy, diversity, modularity, adaptation, prudence and embeddedness. This implies for the financial sector not to worry about too many actors in the market, but to neither worry about failures, it implies the importance of having alternatives around, different business models for different clients and markets, it also implies that financial intermediaries must be constantly aware of the needs of their customers and the corporates they serve, how technology and social developments may have to change the way they do business, it implies caution and considering longer term consequences, and it implies the awareness that all actors in the financial system are part of that system and as a collective are responsible for its stability. In such a world, value is not determined by cashflows only, but also by the value of the commons, clean air, clean water, scarce energy, safety, solidarity in communities.

John Fullerton (2015) comes up with 8 principles for regenerative capitalism, having learned the hard way as a JP Morgan banker on Wall Street. Relationships are the core of the first principle: there’s no us or them, we’re all connected. Then a holistic view of wealth, as the feel of wealth is not necessarily related to the number on the screen representing how much money you own. Third, like Reeves does, he mentions adaptation, innovation and responsiveness, referring to Darwin, who showed that the fittest survive, those who can adapt best, not the strongest. Empowered participation then refers to Reeves’ embeddedness: contributions are to the larger whole. Fifth principle is that capitalism honors communities and place, nurturing healthy and resilient communities and regions. The “edge effect abundance” is about the opportunities for creative innovations and cross fertilization at the edges of the system, where several systems meet or are interdependent. The seventh principle is about a robust circulatory flow. The circulation of money and information and the efficient use and reuse of materials are particularly critical to individuals, businesses, and economies reaching their regenerative potential. Finally, Fullerton stresses the importance of balance: between efficiency and resilience, between collaboration and competition, between diversity and coherence, and between small, medium, and large organizations and needs.

Nassim Taleb (2012) also pointed to the use of abundance for resilience beyond sustainability. He suggests designing a system with apparent superfluous aspects – note nature’s tendency to design systems with seemingly excessive elements. For example, humans having two lungs, two kidneys, etc., which will be immediately recognized as a structure to make us more resilient. In the financial services industry this relates to the importance of substitutability (which is different from competition) and the importance of a diverse banking landscape. Preserving diversity is a means for resilience. Taleb adds the value of stress, and the need to facilitate failing. Small potential for loss, with large potential upside. Within nature, small, continuous stressors are needed to make the species as a whole stronger, and at a certain level also individual actors stronger. In a simple example one needs to use muscle tissue in order for the muscles to still function, and they are stronger to the extent that they are more exercised.

The recent BRRD tries to indeed facilitate banks to fail and forces banks to think of the question “what happens if you’re not there”. This implies banks cannot be too big to fail – size and complexity must come back to proportions that humans can handle. The proof of the pudding is in the eating: when failing appears not regarded politically feasible again, when the credibility of authorities, to have unsound banks fail, appears absent, the situation has become worse and the system will weaken further.

Also relate this to Sabine Lautenschläger’s observation that “less significant institutions” finance most of the economy. Defining smaller, different institutions as significant, namely significant for providing alternative financing services to many different firms, would make more sense, especially when local relationships enrich the quality of financial intermediation (also Boot & Schmeits 2005). The proof of the pudding of the ambition to preserve a diverse banking landscape, as expressed in CRR recital 32, is when supervisors dare to apply different supervisory measures to different banking business models.

Way forward – take common values as a start

As Sabine Lautenschläger clearly expressed: “After all, the aim is to have a functioning banking sector over the medium and long term, providing the real economy with the services that it requires – and it is precisely small and medium-sized institutions that make for a functioning banking sector, as clearly highlighted by the financial crisis.” A medium- and long term resilient banking system requires banks that are sound today and tomorrow and for long. Let’s be clear: a bank can only be in business if it can meet minimum requirements relating to its financial soundness, it is after all, in the business of financial intermediation, intermediating between providers and users of capital. That implies sound solvency, liquidity, leverage, well diversified, well governed, and prepared for a gone concern situation. Fortunately, the crisis showed that those banks in the 3,000-something group that survived pretty well usually have had solvency ratios around 15-20% and leverage of 1/10 for decades. On top of that, personal relationship management, knowing customers personally, contributes greatly to a lower than average loss given default in sectors which other banks would not be willing to finance. Small, local banks typically had loans/assets ratio around 70% throughout the crisis, while their too big to fail competitors had ratios around 40%; similar differences were found for the deposits/total assets ratios (Korslund 2013). At the worst depth of the crisis equity ratios would still be above 10% (Korslund 2013). Typically, values based banks apply a holistic risk assessment when making finance decisions; including not only the usual serie of credit risk, market risk, etc, but also environmental risk, social risk, and the value of the commons. As a consequence, LGDs are lower than those of the biggest banks for the same PDs in comparable portfolios. This relates to Lautenschläger’s “financing 70% of the economy” observation, what we would call significant banks, those banks that appear to matter most when people need them most.

Can we re-humanize also the biggest banks, can we turn them into organisations that no longer have the potential to “significantly” disturb the stability of our financial system? Can we regard numbers as useful input but not as the determinative factor for survival in the financial sector? Can we enhance resilience and agility beyond sustainability? Can we ensure that only activities take place which add value to society? Yes we can. When would banks tend to have only caring owners instead of short-term investors providing their “permanent, fully risk-absorbing, fully subordinated, etc” own funds? We’d have to start with the “why” – the core values driving everything else.

The diagram below is the reverse of what you saw above. Again, the width of the row represents its dominance in everyday choices. I use the living example of values-based banks, those usually unknown to the rest of the world but very significant local players, adding value with financial intermediation at a local level, with the newest technologies, across the globe.

The diagram shows what I would want my bank to focus on day-to-day.

Starting with the why, the bottom-line, adding real economic value to its customers, a specific market with specific needs that a particular bank knows best. Values are about intrinsic motivation, self-awareness, compassion, professionalism and authenticity. They relate to Europe’s values in the European Consitution: human dignity, inclusion, respect and justice. Note that when taking these values as core to a business, it intrinsically implies soundness and safety, as there is not “us” (bankers) and “them” (clients), there’s one community trading with each other and using the bank as their intermediary.

The core values drive the corporate culture; the values determine behavior. Behavior in a values based bank is open-minded towards customers and staff, well-informed, driven, embracing change, empowered and entrepreneurial. The willingness and the ability to adapt in an ever changing world with changing customer needs are intrinsic to a culture based on values.

From values and drivers follows the business model: which part of society does the bank serve, so what is the intrinsic corporate objective, is the model understandable and transparent for the clients it wants to serve, is it sustainable for a longer period of time. Subsequently, the values, culture and business model determine what kind of governance is needed in order to indeed add this real economic value and to do that safe, sound, fair and transparent to all. The governance system includes the (usually three) lines of defence (responsible business, supporting risk management, independent internal audit) and the roles and responsibilities throughout the organization. Naturally, the business model and the governance system include a brake on growth: the bank can only serve it’s community well, if the human beings in it can oversee what’s going on.

And then, basically everything else follows from there.

When most attention is given to a bank’s values, its culture, its business model and the governance that suits these, then strategy is a logical, longer term, supporting element, preparing and supporting the organization to be ready to adapt when necessary, to be agile and resilient when tough times come.

This agility stemming from the strategy determines operations: continuously improving itself, aware of short term and longer term developments, adaptive, and aware of resources.

When most attention is given to values and how to deliver those values safe, sound, fair and transparent, then regulation can be simple and regulatory compliance should no longer be burdensome: solvency, liquidity, diversification and governance are intrinsically sound. The soundness, resilience and agility follow from the internalization of values, a sustainable business model, and an oversee-able size.

Finally, reputation no longer depends on market sentiment and today’s prices. The bank’s visibility and credibility consistently show its raison d’etre. Reputation depends on continuously delivering on the core values. Owners act as committed and patient owners looking after a financially sound company, not as short term driven return-seekers.

I know this is a stubbornly optimistic and probably naive way of looking at finance and financial regulation. Still, there’s several ways to integrate these drivers and the principles of applying the laws of nature which help corporations being resilient, agile and sustainable as part of a bigger whole, into an organization. For example, the Global Alliance for Banking on Values shares a score-card and tools among its member banks. Another opportunity is the High Level Experts Group on Sustainable Finance that the European Commission kicks off this week.

Implications for regulation

The structure of the current regulatory framework for banks actually provides a wonderful opportunity to balance regulatory requirements between numbers, quality, and transparency in its pillar 1 calculations, its pillar 2 assessment of processes and governance, and its pillar 3 information requirements. The urgency that regulators felt, however, to apply this framework especially to the few “significant” institutions, resulted in a Christmas tree of details of which no one had the full overview anymore. The pillar 1 calculation requirements for capital have become so complex, that gaming may be induced as a challenge that many quants at the banks are happy to face. The pillar 3 transparency requirements follow the set of pillar 1 and as such have also become a wood of information in which only very few see the relevant trees (also Boot 2014). And still, sustainable finance is not achieved, as decisions are made on the basis of an incomplete set of risks and values. Sustainable finance is about long-term oriented decision-making that integrates environmental, social and governance (ESG) considerations, which implies a holistic assessment of expected risk and cashflows of projects and investees (Swiss Finance Institute, 2016). It’s possible, and applied, but not obligatory (see also my contributions regarding group risks).

Solvency and leverage requirements regard the most critical prerequisite that bankers had to show their clients for centuries, before clients would be willing to entrust their funds, their savings, to them: own funds, Eigenkapital, fonds propres, eigen vermogen, etcetera. I stress the word “own” here, since it is about showing clients that the banker, or the owners of the bank, would have enough of his own money available to repay the depositors their savings. For centuries the trusted ratio of own funds over entrusted savings was around 1/10. Then in 1988 the Basel Accord formalized that into 8%, risk assessments and risk weights came in, Basel II, and you know the rest of the story. Basel II and III had their explicit objectives, which I fully support. Basel II formalized the necessity of own risk assessments by bankers, the use test: how do you use your risk assessments in the pricing of your exposures? Basel III laid down the minimum level of the quality of own funds. Following the law of nature of redundance (two lungs, two kidneys, two eyes, etc), banks that, as a principle, have had solvency ratios, core equity tier 1 ratios, of over 20%, and leverage 1/10, should be regarded sufficiently capitalized. Additional detailed calculations such as the various buffers then don’t add certainty about the bank’s capacity to withstand big unexpected losses.[2]

Liquidity requirements have to do with the fact that despite high solvency numbers, the balance sheet figures, the figures on the screen, don’t imply that a buffer for unexpected losses and withdrawals is immediately available. This is as much important for small simple banks as it is for giants. Crisis studies revealed that banks with relatively high deposit/funding ratios survived better (Korslund 2013). The liquidity rules thus far were drafted in a way that allows for a proportional application depending on nature, scale and complexity of a bank.

Not pretending a complete review of banking rules in this blog, a final important observation regards disclosure. Disclosure is meant to impose market discipline, i.e. to inform the stakeholders in a company in such a way that they can either confirm their stake in the company, or decide to leave the connection, be it as an owner, a creditor, a depositor, a client receiving funding, or an employee. This requires a holistic view of the firm, in which values that matter most to people are shown and explained. A detailed description of model assumptions etcetera definitely supports some stakeholders and analysts, but as a client of my bank I’d like them to show what my money does, how it supports people and firms, how it enriches the world with new financing alternatives in a sustainable way.

The High Level Expert Group on Sustainable Finance has the opportunity this year to steer the way banks and other financiers are making sustainable decisions, long-term oriented decision-making that integrates environmental, social and governance considerations, which implies a holistic assessment of expected risk and cashflows of projects and investees, as well as the participation by all of us. It can do so in many many ways and I mention only a few: by recommending a review of what-is-value including the value of the commons, i.e. accounting standards, a review of who-participates-in-sustainability, for example by reviewing entrance thresholds for retail investors to participate in new ventures, and third, maybe most important by introducing the obligation to assess not only financial expectations but also environmental and social expectations in the risk assessment supporting finance decisions. To rephrase Christiana Figueres, credited for her enormous and successful effort to get to the Paris Climate Agreement, the world is ready for change, and everyone, also banks, are part of the solution. We’re in this together.


Arnoud Boot (2000), Relationship banking, what do we know? Journal of Financial Intermediation 9, 7–25

Arnoud Boot & Anjolein Schmeits (2005), The competitive challenge in banking, Amsterdam Center for Law & Economics Working Paper No. 2005-08

Arnoud W.A. Boot (2014), Financial Sector in Flux, Journal of Money, Credit and Banking, Supplement to Vol. 46, No. 1

Stephen Covey (1994), The 7 habits of highly effective people

Stephen Covey, A. Roger Merrill, and Rebecca R. Merrill (1994), First Things First: To Live, to Love, to Learn, to Leave a Legacy. New York: Simon and Schuster

John Fullerton (2015) Regenerative Capitalism, Capital institute, New York

Daniel Kahneman (2011), Thinking fast thinking slow, Farrar, Straus and Giroux, New York

Narayanan Kandasamya, Ben Hardyb, Lionel Pagec, Markus Schaffnerc, Johann Graggabera, Andrew S. Powlsona, Paul C. Fletcherd, Mark Gurnella and John Coates (2014), Cortisol shifts financial risk preferences, in PNAS March 4, 2014, vol. 111, no. 9, p. 3608–3613

David Korslund (2013), Real banking for the real economy, GABV report 13-5923 Washington

Sabine Lautenschläger (2016), Caught in the middle, speech,

Joris Luyendijk (2015), Swimming with sharks: my journey into the world of bankers

Martin Reeves (2016) How to build a business that lasts 100 years, TED talk Paris May 2016

Simon Sinek (2009). Start With Why: How Great Leaders Inspire Everyone to Take Action

Swiss Finance Institute (2016), Sustainable Finance in Switzerland: Where Do We Stand?

Nassim Taleb (2012), Anti-fragile, Things that gain from disorder, Penguin Books


[1] Big thanks to Angelique van Gerner for inspiring conversations

[2] Most capital provisions are by their nature proportional to nature, scale and complexity, this goes for most of CRR Part Three Title I, II and III. The less complicated the business model and activities of a bank are, the less provisions apply. Capital provisions that could be disgarded for this set of banks are those in CRD Chapter 4. CRR Part Three Title II Chapter 3 will not be applied; Chapters 5-9 may not be relevant or material (except articles 271-282), and neither will be Title IV, V and VI. Title III justifies a review in itself considering the group risk character of operational risk, think cyber risk, but most smaller banks may benefit from article 313(3) and keep things simple.



The article curtesy of Linda van Goor, Regulatory Communication (The Netherlands). If you wish to comment, please do so following this link.