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«Global TrusT and EThics in FinancE Innovative Ideas from the Robin Cosgrove Prize Carol Cosgrove-Sacks / Paul H. Dembinski Editors Trust and Ethics in ...»

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Motivating ethical behaviour only by trumpeting its financial benefits without discussing its costs is inappropriate. According to some estimates, the average annual income from a lifetime of crime (even counting years spent in prison) is high – it seems that crime does pay. If income were all that mattered, most of us would switch to this lucrative field. The business world features enough cheats and scoundrels who illustrate that a myriad opportunities exist for any professional to break promises – or worse – for money. Ethical professionals turn down such opportunities for reasons related to the kind of people they aspire to be.

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Approaches to dealing with ethical problems in finance range from establishing ethical codes for financial professionals, to efforts to replace the rational profit-maximisation paradigm that underlies the modern capitalist system by one in which individuals are assumed to be altruistic, honest, and basically virtuous. It is not uncommon to find established ethical codes in many countries all over the world that provide sound directions on the conducting of financial markets. Ethical codes for financial markets are established by the official regulatory agencies and self-regulating organisations to ensure ethically responsible behaviour on the part of the operatives in the financial markets.

In search of honesty and altruism

There has been an effort to address the ethical problems in finance by re-examining the conceptual foundation of the modern capitalist system and changing it to one that is consistent with the traditional model of agency relationship. The proponents of a paradigm shift question the rational profit-maximisation assumption that underlies the modern financial-economic theory, and reject the idea that all human actions are motivated by self-interest. They embrace an alternative assumption – that human beings are to some degree ethical and altruistic – and emphasise the role of the traditional principal-agent relationship that is based on honesty, loyalty, and trust. R. Duska (1992) argues: “Clearly, there is an extent to which [Adam] Smith and the economists are right.

Human beings are self-interested and will not always look out for the interest of others. But there are times when they will set aside their interests to act on behalf of others. Agency situations were presumably set up to guarantee those times.” The idea that human beings can be honest and altruistic is an empirically valid assumption; it is not hard to find examples of honesty and altruism in both private and public dealings. There is no reason why this idea should not be embraced and nurtured. As N. Bowie (1991) points In Search of Honesty and Altruism 323 out: “Looking out for oneself is a natural, powerful motive that needs little, if any, social reinforcement… Altruistic motives, even if they too are natural, are not as powerful: they need to be socially reinforced and nurtured.” If the financial-economic theory accepts that behavioural motivations other than that of wealth maximisation are both realistic and desirable, then the agency problem that economists try to deal with will become a non-problem. For J. Dobson (1993), the true role of ethics in finance is to be found in the acceptance of internal good (“good” in the sense of “right” rather than in the sense of “physical product”), which, he adds, is what classical philosophers describe as “virtue” – that is, the internal good toward which all human endeavour should strive. He contends: “If the attainment of internal good was to become generally accepted as the ultimate objective of all human endeavours, both personal and professional, then financial markets would become truly ethical.”

The Grameen Bank and financial ethics

The experience of the Grameen Bank serves to highlight the straightjacket on ethical issues that most of us must accept as we seek to serve our institutions. Nevertheless, exceptions remain possible – those who remain within the financial world and yet attempt to impose their own ethics of belief – to the extent that the institutionalised system is in fact forced to concede. The experience of the Grameen Bank serves to highlight this possibility. In the wake of the 1974 flooding in Bangladesh that had led to widespread crop failures and hunger, Professor Muhammad Yunus at Chittagong University in the southern part of the country, was conscious that his abstract economic theories were far removed from the reality of local village populations. Even in more fortunate times, these people had been obliged to remain poor, because the greater part of the value added by their endeavours was exploited by those who financed their activities. For example, the rickshaw pullers who after twenty years still could not become the owners of their rickshaws.

324 Trust and Ethics in Finance Money was required to make money, so that is seemed that the purpose of the poor was to make the wealthy rather wealthier. Yunus began with a list compiled by his students containing the names of forty-two local people, whose initial capital requirements, in order to purchase materials to work freely, added up 856 takas, about US$26. The villagers accepted the money as a loan and Yunus arranged for its repayment in small daily instalments.

When Yunus attempted to persuade a bank to provide a loan to the villagers on the same principle, he was informed, notwithstanding the evidence of his own experiment, that the bank could not lend money to the poor because they had no collateral and would therefore not repay.

For this reason, governments, not banks, existed to help the poor. The bank would lend to Yunus but not to the people. That was the rule of the bank.

A socially conscious capitalist enterprise For Yunus, the principle was that the bank should be prepared to fund the entrepreneurship of the poor, not his own collateral. In the end, Yunus achieved his first loan of 10,000 takas (US$ 300) with the compromise of being the guarantor himself, while simultaneously actually promising the bank that should the villagers fail to repay their loan, he would be under no obligation to repay the bank. When the experiment turned out to be a success, Yunus approached the bank to continue the experiment in its own name. He was told that he must submit a proposal for a project with a budget, which the manager could send to his boss, who in turn might decide to send it to his managing director; but he was warned: “Even the managing director cannot give his authority just like that. He has to take it to the board and the board has to decide. And there are things that the board cannot change, because they have to do with fundamental principles of the bank. So you have to go to Parliament or whoever made the laws for that. And your suggestion involves that kind of change” (Bornstein, 1996).

In Search of Honesty and Altruism 325 In the end, with a loan from the bank, Yunus opened the first branch of his Grameen (the word gram means village) Bank in the village. True to its name, the Grameen Bank works only in villages, which is one of the ways it has redefined the idea of a bank. Another is that it lends mainly to women in small amounts and for short periods of time. Yet another is its method of screening borrowers. To qualify for a loan, a villager must show that her family’s assets fall below the bank’s threshold.

She will not be required to furnish collateral, demonstrate a credit history, or produce a guarantor. Instead, she must join a five-member group and a forty-member centre, and must assume responsibility for the loans of her group’s members.

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 Two decades later, the bank has extended an equivalent of US$ 3 billion in tiny loans for self-employment purposes to 2 million of some of the poorest people in the world, mainly women. It has lent half that amount in just two years. With loan repayment exceeding 98%, it has outperformed all other banks in Bangladesh and most banks around the world. Nevertheless, the Grameen Bank is not a charity. Interest rates are commercial, and have been as high as 16%. It is a business that scrupulously controls costs and aims at profitability while adhering to a 326 Trust and Ethics in Finance social programme whose mandate is to end poverty and hunger, not just in Bangladesh but from the face of the earth. Yunus maintains that the bank represents a socially conscious capitalist enterprise.

Grameen Bank vs. world financial systems The Grameen Bank crosses the gap between an entrepreneurial institution that has actually made the case for less “charitable” government, and an enlightened social welfare institution that argues in favour of the value of government involvement that is able to conceptualise in terms of the potential of people to add to their own lives. For Yunus, the problem is that the financial systems through which governments of developing countries attempt to operate do not inherently believe in people, whose poverty alleviation has been largely forgotten, but in wealthgenerating projects understood in terms of “income” and “GNP”. Nonetheless, if increases in the villagers’ incomes are to be achieved by movements of the population from the village to the vastly overpopulated city – where expenses are also many times increased – it is by no means clear that increases in income – and GNP, which measures such increases – are the good thing they are made out to be. Added to which, GNP does not recognise half the population’s (women’s) work, while the concept of income appears to be understood in terms of statements such as “Bangladesh has a per-capita annual income roughly equal to US$ 200”. If this indicates that people in Bangladesh live for an entire year on the quantity equivalent to what a New Yorker can receive for US$ 200, is nonsensical, since they would have all died; and if it does not mean this, it is unclear what it does mean. To date, the government of Bangladesh has acquired more then US$ 25 billion in institutional aid for infrastructure projects such as roads, bridges, and power stations.

Notwithstanding that Bangladesh needs these kinds of things to attract investments; Yunus believes that many of the ideas have been so illconceived by the World Bank experts, that the country has been turned into a graveyard of ideas and projects, with little or no impact on the In Search of Honesty and Altruism 327 poorest 50% of the country. And the debt constraints remain. For Yunus, the system is financially flawed because the concept of linking income and GNP – rather than real concerns for people and an appreciation of their potential to engage productively as individuals in their own right – are responsible for the accounting systems that produce the figures, that in turn determine public policy. In effect, Yunus holds out the possibility that society’s profit-maximisation objective at the macro level is ultimately compatible with assisting the poorer members of society to help themselves.

The Grameen Bank remains committed to a clientele that is inherently expensive to serve – a clientele that in the absence of an ethical imperative would have remained outside of the big capital markets. The example is perhaps daunting, emphasising the compromised position that we may feel with regard to the ethical codes of our financial institutions today. On the other hand, the example is perhaps uplifting, demonstrating that a single individual, who remains committed to its beliefs, can have the potential to initiate a significant paradigm shift in the ethical functioning of financial institutions, within which most of us seek to leave a mark of our creative energies.

References Bornstein, D., 1996. Price of a Dream: The story of the Grameen Bank. Chicago, University of Chicago Press.

Bowie, N., 1991. “Challenging the Egoistic Paradigm”, Business Ethics Quarterly, Society for Business Ethics, No1.

Bruner, R., 2006. Ethics in Finance, Working Paper, Charlottesville, University of Virginia.

Dempsey, M., 1999. An Agenda for Window-Dressing or for Radical Change?, Working Paper, Nathan, Griffith University.

Dobson, J., 1993. “The Role of Ethics in Finance”, Financial Analysts Journal, Vol. 49, No6.

Duska, R., 1992. “Why Be a Loyal Agent? A Systematic Ethical Analysis”, in:

Bowie, N./ Freeman, E. (eds.), Ethics and Agency Theory: An Introduction, New York, Oxford University Press.

Wicks, A., 2003. A Note on Ethical Decision Making, Working Paper, Charlottesville, University of Virginia.

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Microfinance institutions are currently experiencing very high repayment rates of between 95-99%. Coupled with growing loan sizes by clients, these institutions are even making profits. No wonder there seems to be a good reason for the world to celebrate the microfinance revolution. It is not necessarily wrong to reduce poverty and make some money on the side. The question however arises as to whether that is indeed what is happening with microfinance.

R.P. Christen (1997) defines microfinance as the means of providing a variety of financial services to the poor, based on market-driven and commercial approaches. These services may include savings, insurance, money transfers and credit. However the microfinance movement to date has generally favoured microcredit, which is the provision of small loans to households who are perceived to be too poor to qualify for loans from formal financial institutions. This essay mainly discusses microfinance to these very poor clients who cannot even borrow as individuals, but must borrow through a joint liability group.

330 Trust and Ethics in Finance Poor households are caught up in a vicious cycle of poverty, where labour, their best resource, is locked up due to different constraints including a lack of liquidity. The household’s productivity as such is limited to a level whereby the available household income is insufficient to sustain good standards of living. For example a poor household may have family members who are willing to work in the family garden to grow sufficient food crops. However if they cannot afford improved crop varieties and farm inputs then it will not be possible for the family to grow enough food. The household’s labour is therefore said to be locked up due to a liquidity constraint among other constrains. Many governments and donor communities believe that the liquidity constraint is the most important constraint impeding poor households and that if it is addressed it will be possible for households to escape poverty.

Economists argue that to break the vicious cycle of poverty, there needs to be an outside force that will break the vicious chain by injecting some liquidity, thereby unlocking the household labour. Microfinance promises not only to break the vicious chain of poverty but also to initiate a whole new cycle of virtuous spirals of self-enforcing economic empowerment that leads to increased household well-being.

Misleading assumptions

Such is the model that has promoted the microfinance institution and given it the polite and respectable image it currently enjoys. With all due respect, it is worth raising some questions regarding the underlying assumptions of such a popular model.

In the first place, proponents of the model assume that many poor people can become micro-entrepreneurs. Entrepreneurship skills and managerial capability are assumed as given, thus the ability for microfinance to create employment even if self-employment. Secondly, even if the first assumption were correct, the model continues to assume that there is going to be a vibrant market for goods and services and that it Microfinance 331 will be possible for all micro-entrepreneurs to gain access to markets for their products; otherwise how else can incomes be improved from entrepreneurship if there were no markets? Thirdly, the supporters of this model also assume that as long as the poor can repay at market rates, or slightly above market rates, it is a good indication that they are doing well financially. Ironically, one of the major reasons why it was felt so justified to bring more formal financial services to the poor was because it was assumed that the local money lenders were exploiting the poor by charging extortionate interest rates. Yet the poor were paying even then!

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