Last updated: May 2009
The following article is an edited version of the ‘El Escorial Statement on Banks and the Financial Crisis’ made by BankTrack during November 2008. BankTrack is an international network of non-governmental organisations monitoring commercial banks. It advocates a socially and environmentally sustainable banking sector which provides services that benefit society as a whole.1
The world financial system is on the brink of collapse. The crisis that is pervading the banking system has spread to other sectors of the economy, affecting the lives of millions of people. Banks’ irresponsible and unsustainable behaviour, driven by greed and kept unchecked by a failing regulatory system, has been at the core of the crisis.
In our view, the crisis has three main dimensions: A financial and economic crisis The financial meltdown has been characterised by a collapse of trust among banks, bank insolvency, and deleveraging (paying off debt). This led to a severe crisis of confidence, on which the banking sector ultimately depends. As distrust takes over and money flows dry up, credit tightens, and the world is heading into a recession whose depth and duration no one can predict.
A social and environmental crisis
The reckless, speculation-driven expansion of the financial markets has led to a disconnection between the amount of capital at play in the ‘casino’ economy (where money is solely made from money) and the real economy. Capital could have been deployed on investments that would help meet the basic needs of millions of people, and on financing the global energy shift urgently needed to avoid a global climate catastrophe. Unfortunately, banks’ financing activities in the real economy has fallen short of this, often harming communities and ecosystems instead.2
The financial crisis has also diverted international attention, financial and other support, from addressing urgent issues facing the world’s poor. The suffering of the 290 million people hit hardest by today’s food crisis could be relieved if the G8 countries could give two extra cents for every $1 they have spent so far on bailing out the banking industry.3
A governance crisis
Through political interventions over the last decade, the financial industry has effectively usurped the power and role of financial regulators and supervisors.4
Banks’ successful deregulatory efforts have allowed them to engage in excessive risk-taking in the pursuit of short-term profits. To deal with the serious problems that have now arisen, and to prevent them reoccurring, BankTrack believes that all dimensions of the crisis need to be dealt with simultaneously. Steps to solve the governance crisis Self-regulation is no regulation. For years governments have taken a hands-off approach, allowing risky activities to go unregulated, and banks to circumvent existing rules. Weak regulations led to the creation of the ‘shadow banking system’, largely responsible for the expansion of unregulated, exotic securitized products and credit derivatives. In 2007 the notional value of over-the-counter derivatives amounted to about US$596 trillion, almost 10 times larger than world GDP.5
This huge unregulated part of the sector increased systemic risks and played a key role in creating the financial crisis. Largely operating out of tax havens, some shadow banks are actually non-bank institutions such as hedge funds. Other such operators have been established by banks themselves (for example, structured investment vehicles) to avoid regulations such as capital adequacy requirements. Under a system of self-regulation, banks were not able to take any meaningful coordinated they found themselves, forcing governments around the world to bail them out.
To avoid this situation in the future, BankTrack believes that it is necessary to:
Get banks out of politics
Decreasing the political influence of banks (and all corporations) is critical. According to Nobel Prize winner Joseph Stiglitz, “Much of the inadequacy of current regulations and regulatory structures is the result of financial markets’ political influence, in many countries through campaign contributions. These deeper political reforms, including campaign finance reform, are an essential part of any successful regulatory reform.”6
Require banks to seek a social licence to operate
Society must regain the means to control and correct banks, and redefine their primary role as investing in the real economy and advancing environmental sustainability. Banks need to earn their social licences to operate and provide products and services which serve, rather than harm, the public interest. Ensure democratic participation in designing a new global financial order BankTrack supports the development of a new global financial order to prevent future financial crises. New policies and institutions must be developed in a participatory and democratic manner, ensuring strong participation and support from developing and emerging countries.
Steps to solve the environmental and social crisis
The world is in need of a ‘Green New Deal’ which would transform the economic system into one that helps solve the pressing social and environmental crisis. The fiscal spending necessary to stimulate crisis-affected economies entering recession should be directed at achieving social justice, the promotion of sustainable production and consumption systems, and the transition of the world’s economies onto a low carbon path.
Banks, particularly those that were bailed out with tax money, have an important role to play and must serve the public interest, rather than safeguarding the profits of the few. Given their power, banks can, and should, deploy capital in ways that promote the restoration and protection of the environment and help create sustainable economies. They should, for example, move away from fossil-fuel-based energy projects into low carbon options and commit to reduce the greenhouse gas emissions in their financial portfolios.
Policy makers also have a critical role in establishing a new bank regulatory regime that proactively stimulates this economic transition.
Sustainability-oriented standards should be incorporated into all bank supervision, including the granting of licences, and the extension of central bank-provided credit and insurance. A sustainable Basel Capital Accord Banking regulators should mandate the inclusion of environmental and social issues into risk assessment processes for bank financing activities. One possibility is to include a set of sustainability criteria into the Basel Capital Accords capital adequacy ratios.
Green screening of customer
Know Your Customer (KYC) guidelines are anti-money laundering (AML) mechanisms used by banks to screen potential depositors. Similar ‘Green KYC’ guidelines should be developed, requiring banks to conduct environmental and social due diligence for commercial depositors and borrowers, and prohibit them from lending to corporations that do not comply with environmental and social laws. Existing AML requirements should be tightened to halt the proceeds of corruption, illicit natural resource deals and tax evasion from entering the financial system.7
Banks should be completely transparent about their risk assessment processes, decision-making procedures, clients, and transactions. Banks should fully disclose their financing activities in the sectors with high environmental and social impacts. Steps to solve the financial crisis Current efforts to reform the financial markets must include clear prohibitions on certain financial practices and structures. Eliminate shadow banking Eliminate the shadow banking system by regulating all unregulated financiers and financial products and forbid certain financial practices completely. Banks should not be allowed to create any structured investment vehicles and/or special purpose entities which allow them to avoid regulations.
Abolish tax havens
Secrecy jurisdictions not only allow companies, financiers and individuals to evade taxes, but to avoid regulations as well. Tax havens resulting in the fight of up to US$800 billion per year from developing and emerging market countries alone, have significant impacts on the world’s poor.8 Banks should be prohibited from establishing or conducting transactions with entities based in these jurisdictions.
Finally, financial regulations should be dramatically strengthened:
Regulate alternative investors such as hedge and private equity funds, and introduce new transparency and reporting requirements. While initially it was believed that only wealthy, sophisticated investors participated in such funds, it is now apparent that many public institutions and pension funds have significant exposure to them, magnifying their impacts on ordinary citizens and the global financial system.
Extraordinarily high returns are often linked to an excessive amount of borrowed money(leverage) and/or temporary wealth associated with inflating bubbles. As over-borrowing and the subsequent deleveraging (paying off debt) are drivers of the current crisis, the use of leverage in investments and lending should be limited.
It has become clear that derivatives are potentially dangerous products. As with other potentially dangerous goods – e.g. pharmaceutical products – regulators demand robust testing before a product can be sold. Equally, derivatives should be checked for their long-term impacts and whether they serve a legitimate hedging purpose (i.e. help producers to anticipate and adapt to price fluctuations).
Only legitimate hedging instruments should be allowed, and they should be standardized and traded in regulated exchanges. The need to curb speculative derivatives trading is particularly critical in food and energy-related commodities markets. Huge swings in commodity prices and speculation-fueled spikes in food and energy prices hurt the world’s poor. Food and energy should not be treated like chips in a casino.
Reduce incentives for excessive risk taking
Banks’ perverse incentive structures, like stock-options and short-term, volume-oriented bonuses, stimulated excessive risk taking and effectively led to greed-oriented decision-making at banks. CEOs and bankers have compromised lending standards (including environmental and social policies), taken on too much leverage, and unscrupulously pushed risky products onto the public. Not only should bankers’ executive compensation be drastically limited, but the role of bonuses should be changed to reward long-term financial success and the implementation of environmental and social policies and programs.
We face a time of dramatic change that presents unique opportunities. Now that the once-dominant forces of market fundamentalism have been discredited, a new, equitable, and sustainable future can be built on the rubble of past excesses.
1 Statement drafted at BankTrack annual strategy meeting in Spain on 6/11/08. www.banktrack.org
2 BankTrack’s Dodgy Deals: www.banktrack.org
3 NGOs warn poor countries neglected in fnancial bail-outs, 17/10/08, www.oxfam.org/en/pressroom/ngos-warn-poor-countries-neglected-fnancial-bail-outs
4 In the US, the fnancial industry has more than quadrupled its federal campaign contributions since 1990, and
is now the leading source of support to federalcandidates and parties www.opensecrets.org
5 Bank for International Settlements, www.bis.org/statistics/otcder/dt1920a.pdf
6 Joseph Stiglitz, Testimony to House Financial Services Committee, 21/10/08 at www.house.gov/apps/list/hearing/fnancialsvcs_dem/stiglitz102108.pdf
7 AML requirements should apply to all fnancial actors and transactions, including hedge funds and private equity. The Financial Action Task Force should also launch a name and shame initiative focusing on those jurisdictions that are failing to implement their AML rules.
8 Baker, Raymod, Capitalism’s Achilles Heel, 2005.