Extreme Makeover: Why The Banking Industry Needs A Wholesale Change In Values

The crisis in the financial markets has made economic sustainability a principal objective of organisations and investors.  What is equally true is something that we have all known for years; financial reporting and financial risk management are insufficient measures of economic sustainability – even when they are supported by an array of internal auditors, external auditors, controllers, risk managers, regulators and central banks.

Many organisations have recognised this and attempted to augment their risk reporting and risk management practices by a number of ethics, corporate governance and CSR related initiatives. The financial crisis has now exposed these as also being insufficient.

In this article we will explore why these approaches failed and why there is a need to look at organisations as ecosystems of human assets in which values play a central role. The analysis will show that the failure of the banking industry is due to a failure in its ecosystem of values, and that changing said values are the best path to rehabilitation.

We will then examine the particular importance of human values and how, with reference to such entities as Merrill Lynch, Citigroup, HBOS and UBS, both the economic sustainability and competitive advantage of an organisation is best defined by its ability to instil human values into every aspect of its activities.

Finally, we will examine a strategic and operating model, The Human Asset Business Model, which allows an organisation to link its values to its economic sustainability and competitive advantage, thereby facilitating effective management of all three.

Ethics, Corporate Governance, CSR

Organisations have viewed ethics and corporate governance as a path to economic sustainability. The stringent regulations of Sarbanes-Oxley were specifically designed to restore public confidence in the capital markets through better governance.

However, a study of corporate governance by a team at Stanford Graduate School of Business concluded that such thinking is misguided. It appears that the financial crisis has confirmed this.

The problem with most corporate governance strategies is that they exemplify a rigid, top down and mostly inward looking approach to economic sustainability. These strategies are unsustainable because as we will illustrate later, they lack the necessary human engagement required to sustain them.

CSR and its presumed linkage to the greater good was also supposed to improve economic sustainability. However, we can be sure that every single failed or failing institution had or has a wonderful and well documented CSR policy. So too did BP, who were busy sponsoring the local Boy Scouts even while their inadequate attention to maintenance resulted in a devastating and deadly explosion at their Houston plant.

It is obvious that the answers to our problems are far beyond the scope and capabilities of any of the current approaches to economic sustainability. Any possible solution must begin with a more thorough analysis of the problem.

The Banking Industry: Anatomy Of A Collapse

The modern organisation has no boundaries – something that many governance and risk approaches do not always fully appreciate. Organisations are ecosystems of human assets; employees, managers, customers, suppliers, and the community.

How well these human assets perform will be dependent on both their individual capabilities as well as their ability to work together in pursuit of their shared mission. If the performance of a single human asset is impaired it will impact the entire ecosystem.

The analysis demonstrates how this caused the collapse of the banking industry.

• Employee incentives prioritised short term profits and bonuses
• Management placed too much faith in financial risk management and  complex mathematical models
• Banks did not pay sufficient attention to the financial security of their Customers
• Small banks were Suppliers of ninja (no money no job) loans for securitisation
• Rating agencies were less than credible Suppliers of financial information
• Institutions generally failed in terms of their responsibility to the Community

In each case, human assets were diminished by an absence of the right values. Poor values resulted in poor human assets which in turn resulted in a very poor performance.

Values are therefore integral to the economic sustainability and performance of organisations. A failure to maintain the right values will have adverse consequences on an organisation’s future.

The travails of Citigroup are a prime example of why it is extremely important to ensure that an organisation’s values encompass every aspect and every sphere of its business.

Organisations Must Not Grow Beyond Their Ability To Sustain Their Values

In an article entitled A House Built On Sandy (a none too pleasing reference to former Chairman Sandy Weill), The Economist describes the decline of Citigroup thus:

Universal banking need not fail. But smaller, focused organisations are easier to run than large, sprawling ones—Citigroup has more employees than the American navy and, apparently, greater destructive power.

The article then went on to elaborate on how Citigroup lost its way by growing beyond its ability to coherently manage its vast franchise.

Citi has been built through deal making and it shows. Acquisitions were poorly integrated. Cultures overlapped rather than melded...It may be inevitable that some banks are too big to fail; but the lesson of Citi is that they can also be too big to manage.

Citigroup’s failure was that it had grown beyond its ability to inculcate and sustain its values. When an organisation finds itself in such a situation it directly impacts both economic sustainability and performance and there is very little that top down edicts on ethics, CSR and corporate governance can do to redress that situation.

Toyota, for example, has one of the strongest and most disciplined approaches to sustaining values of any organisation. Yet, production problems in the US led to concerns that rapid expansion had impacted the organisation’s ability to sustain its values and with it the quality of its products.

Unlike corporate governance, values can neither be dictated nor enforced from the top. It is what makes mergers and acquisitions so difficult. It is why Citigroup is in its current predicament. It is also a warning to governments in the US and the UK who are trying to remedy the financial crisis by forced mergers of large institutions. In all probability they are now sowing the seeds of another future catastrophe.

An organisation’s relationship with the external environment, its acquisition strategy and how it responds to and incorporates new ideas and new products must be guided by its values. The following tale of two institutions is a further vivid illustration of why.

A Tale Of Two Institutions

Several years ago I went for an interview with Merrill Lynch, London. During my discussions with the then Head of European Equities, he asked me what I thought their year-to-date trading profits were. I deliberated, considered that it was well into the financial year, and that this was at that time the world’s largest Equities house.

So I gave a response which was somewhere in the countless millions, only to be advised that the number was only about $500,000. On seeing my astonishment my interviewer explained that Merrill Lynch was not a high risk trading house but an institution proud of the fact that its profitability was driven by having a wholesale customer business that was strongly supported by and integrated into its retail network.

A few years later Stan O’Neal became CEO and dramatically altered the culture and along with it the risk profile and values of the institution. What followed next is best summarised by Landon Thomas and Jenny Anderson in the New York Times of October 29, 2007:

Mr. O’Neal’s fall has been stunning in its speed and ferocity. This spring, Merrill’s stock was trading around $95 a share, and Mr. O’Neal was being celebrated for transforming Merrill into a more aggressive, risk-friendly institution. Last week, the stock sunk to as low as $59 a share. Initially, the increased risk was a boon — part of a shift from the firm’s classic position as a money manager with an excellent stock underwriting business to a bank that had become increasingly hooked on the high-octane, high-risk returns that came from investing its own money.

In contrast, Wells Fargo under Chairman Richard Kovacevich stuck to its core values irrespective of what was happening in the markets. As noted by Gina Keating of Reuters.

Wells Fargo lost 4 percent of market share per year between 2005 and 2007, and millions in fees in 2006 alone because of its refusal to sell the type of risky mortgages that are now undermining the U.S. Economy.

In the end Merrill Lynch collapsed into the arms of Bank of America while Wells Fargo went on to acquire Wachovia, another failing institution which was previously the 4th largest banking franchise in the US.

Similarly, the failure of UK institutions, such as HBOS and Northern Rock, was directly related to their inability to transition from a business and risk culture built around customer deposits, to one which required a thorough understanding of the wholesale markets which they had ventured into.

Exactly the same arguments can be made for UBS. Chairman Marcel Ospel tried to transform the world’s largest wealth manager into the world’s largest investment bank. His supreme folly has resulted in the largest losses in Swiss corporate history. This has being further compounded by the Bank’s violations of US tax laws.

Economic sustainability requires a strategic decision making process that emphasises values over short term financial returns. This is not to say that values ignore the importance of returns. In fact, as the next section demonstrates, values are now the most important factor in organisational strategy and competitive advantage.

The Strategic And Competitive Importance Of Values

In his book entitled Built to Last, James Collins notes; “It is better to know who you are than where you are going because where you are going will most certainly change...”

What an organisation is, what it stands for, its business model and strategic objectives are all ultimately determined by its values. As indicated in the table below, almost all industries are being driven by what I call human value imperatives.

Industry	Human Value Imperatives
Oil, Auto, Utilities	Clean and efficient energy
Food & Beverage	Health, nutrition, obesity
Financial institutions	Responsible lending, personal financial security
Pharmaceuticals	Affordable medicines e.g. for HIV
Hotel, Leisure	Efficient use of natural and other resources

This is not merely a current phenomenon. The impact of human values on human assets has been at the forefront of every seminal event in the modern history of industry and commerce.

The Industrial Revolution was brought about by ordinary people e.g. Robert Stevenson started life as a cowherd, who motivated by sound patent laws and the legal certainty of investment returns, created basic goods and services for ordinary people.

Henry Ford’s Mass Production exemplified the focus on human values. Ford, decided to build cars such that “everybody will be able to afford one, and everyone will have one”, and paid his workers twice the going rate in order to achieve it.

Toyota’s Lean Production was built on the foundations of employee development, freedom and empowerment – all made possible when the post-war Japanese Constitution outlawed any distinction between blue and white collar workers.

Finally, the IT Revolution was made possible by way of a social revolution, symbolised by young entrepreneurs who had a passion for their pastime and who generously shared the rewards of their efforts with their collaborating partners.

Human Values and their impact on Human Assets will be at the core of the next revolution. Examples of organisations that have adopted successful human value strategies as way of aligning and motivating the performance of human assets include:

Merck, whose mission is “to provide society with superior products and services by developing innovations and solutions that improve the quality of life”.

Google, whose mission is “to organise the world’s information and make it universally acceptable and useful”.

Not just values but human values are the defining factor in the economic sustainability and competitiveness of organisations and we can illustrate their importance thus:

Human values can neither be legislated nor dictated from the top down. They can only be lived. The challenge therefore is to develop a strategic and operating framework for instilling them into an organisation’s ecosystem such that they are embodied by all its human assets. This is precisely what The Human Asset Business Model is all about.

The Human Asset Business Model

The Human Asset Business Model defines the organisation as a series of relationships between human assets and their shared human values. It is the human representation of an organisation’s ecosystem and it conforms to the well known dictum that the value of an organisation is in its people.

Each human asset relationship is influenced by the impact of shared values on the specific factors that determine its worth. So for example, the employee to customer relationship is dependent on the impact of the customer value proposition on factors such as salesperson knowledge and customer collaboration. Together these and other factors will define the extent and sustainability of an organisation’s customer franchise.

The better the human asset relationships, the better an organisation’s economic sustainability and long term competitiveness – the model itself provides the framework for making this assessment. An organisation with a high degree of economic sustainability and competitive advantage will exhibit the following characteristics:

Human Asset Relationship	What Happens When Human Asset Relationships Fully Embody The Values
Employee to Self	Individuals share in and embody the organisation's values and are engaged and motivated to perform
Employee to Employee	Employees share and live the values and enthusiastically collaborate to achieve the mission
Employee to Management	Management embodies the values. Relentlessly focus on instilling those values to develop human assets
Employee to Organisation	IT, Systems and Procedures effectively facilitate human assets in delivering the mission and values
Employee to Customers	Customers have a strong desire to share in the value proposition and are integrated into the business
Employee to Suppliers	Suppliers have a strong desire to share in the value proposition and are thus integrated into the business
Employee to External Knowledge	The organisation's strategy and response to external change is consistently guided by its values
Employee to The Community	The organisation’s values benefit the community and are a source of competitive advantage

Such an organisation is known as The Human Asset Organisation.

Summary

Financial reporting and risk management have once again proved to be inadequate predictors of economic sustainability. At the same time ethics, corporate governance guidelines such as Sarbanes Oxley and CSR have been unable to take up the slack.

The crisis in the financial markets is due to a failure of values throughout the entire banking ecosystem.

The experience of Merrill Lynch, Citigroup, HBOS, Northern Rock, UBS and Wells Fargo all indicate that economic sustainability is only assured when the right values are integrated into the every aspect of an organisations strategy and operations.

Organisations place themselves at great risk when they grow beyond their ability to sustain their values, or when their strategic decision making process ignores those values.

The history of modern industry and commerce shows that the right combination of human assets and human values are essential for creating both economic sustainability and a competitive advantage. Organisations must therefore create a strategic and operating framework for achieving this; essentially a complete makeover of their values.

The Human Asset Business Model is such a framework. It leads to the creation of The Human Asset Organisation where by definition; all human assets are aligned with and embody the same human values and objectives.

The extent of the human engagement required suggests that neither top down corporate governance nor rigid legislative approaches are likely to provide an appropriate framework for achieving the objectives of The Human Asset Organisation.

Jonathan Ledwidge is author of The Human Asset Manifesto and founder of THAPartners
Email: jonathan.ledwidge@thapartners.com
Phone: +44 (0) 7795 035229

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