The challenge for financial services

Writing in Investment Adviser, Professor Ken Starkey calls on the financial services industry to revolutionise its approach to incentives and change its attitude to its role in the economy and to customers.

This piece appeared in Investment Adviser as ‘Economic liquidity now dances to a different tune’ on April 18 2011

It was Citigroup chief executive Chuck Prince who infamously declared in 2007: “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing you’ve got to get up and dance. We’re still dancing.”

Only a few months later Prince was waltzing out of the ballroom. Citigroup, like many of its peers, was dancing to a different tune – that of lost billions. Financial meltdown was in full swing. The era of economic narrative as mood music was reaching its coda.

In understanding how this particular score was allowed to play for so long – and how we might successfully replace it with a piece more suited to a wider audience – it is first necessary to identify its original composers.

In effect, it was written by Nobel-Prize-winning economists whose theories argued that a certain form of economic rationality was creating a brave new world. The work of Nobel laureates such as Merton Miller, Myron Scholes and Robert Merton laid the foundations not just for a financial environment driven by myths – the most powerful among them that of the efficient market – but for a particular form of financial economics to triumph as the management narrative of our time.

In keeping with the American philosopher Nelson Goodman’s notion of “worldmaking”, this narrative became firmly established. It dictated the way the world was supposed to work. Options, derivatives, leverage as a key to prosperity, self-regulating markets, self-correcting problems, built-in controls, risk management – to borrow Goodman’s phrase, the given was acknowledged as taken.

And it did not stop there. The JP Morgan Guide to Credit Derivatives – which argued that credit derivatives were the best way of managing illiquidity and risk – was referred to within the company as “the bible”. Goldman Sachs claimed to be doing “God’s work”. Wall Street saw itself as home to the self-appointed “masters of the universe”. The finance industry metamorphosed into a self-proclaimed “engine of growth”, “the main driver” and “the golden goose” of national economies.

As rival narratives withered, traditional business models became redundant. The concepts of service and customer relationships were forgotten. Long-term investment in the productive economy was supplanted by the search for greater profits among the intricacies of casino banking. Borrowers, bereft of insider knowledge or impartial advice, were encouraged to be reckless.

As late as 2007, when Prince was “still dancing”, Alan Greenspan proclaimed: “Since markets have become too complex for effective human intervention, the most promising anti-crisis policies are those that maintain maximum market flexibility.” In other words, the most promising anti-crisis policies are those that involve minimum regulation.

Come 2008, when called to account for his role in global financial meltdown, Greenspan conceded he had “found a flaw” in his economic ideology. “I made a mistake,” he said, “in presuming that the self-interest of organisations – specifically, banks and others – was such that they were best capable of protecting their own shareholders and the equity in the firms.” Some mistake.

The most urgent of the challenges now confronting the financial services industry is the need to fashion a new narrative – one far removed from a Darwinian struggle for survival amid cut-throat competition in “efficient” but merciless markets. There must be an alternative to the privatisation of gain and the socialisation of loss.

A return to service and relationships is a key first step. It is no coincidence that independent financial advisers and brokers have historically topped the Financial Services Research Forum’s quarterly Trust and Fairness Indices. The attributes consumers value – a capacity to explain products and services, an ability to provide suitable advice and even a willingness to exhibit a measure of courtesy – are embodied in the ideal IFA.

The long-term aim must be to develop strategies that lead to sustainable shareholder, customer and societal value. The balancing of these sometimes competing objectives will require new kinds of management and new forms of education and training (and in that regard business schools will have their own part to play). It will call for an evolutionary – or even revolutionary – approach to incentives. It will demand the emerging of banking from its self-imposed shadows.

Credibility has to be re-established. Trust has to be re-earned. The necessary cultural change is likely to be vast.

Ultimately, what the industry does for the rest of the economy, not what it does for itself, should be the genuine gauge of its worth. It is the perceived selfishness of banks that has made them hate figures.

Rolling Stone described Goldman Sachs as “a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money” – not exactly in keeping with the bank’s own “God’s work” assertion.

Only a shift in industry attitudes can trigger a shift in consumer attitudes. “Business as usual” is the last thing the public wants to hear. The music has well and truly stopped. It is time to change the record.

Ken Starkey is a Professor of Management and Organisational Learning at Nottingham University Business School, where he is also Director of Research. The School is a leader in research and teaching on innovation, entrepreneurship and sustainability and runs executive education programmes under the banner title The New Language of Business.