A recent study has found that ethical banks, grounded in the real economy, consistently out-perform their largest non-ethical peers. So we asked the report’s lead author, why aren’t more banks taking this approach?
Ethical banks consistently out-perform their largest non-ethical counterparts according to the latest research from the ethical bank network, the Global Alliance for Banking on Values (GABV). However, most start-ups and more or less all incumbent banks still cling to the old, broken model. Can this sort of analysis, combined with investor and regulator pressure, move ethical banking into the mainstream?
Covering 2010 to the end of 2016, the updated annual analysis concludes that VBBs (Values-based banks and banking co-operatives) “have constantly shown that serving the real economy delivers better and more stable financial returns than those shown by the largest banks in the world”.
The work compares the publicly available financial performance data of 37 VBBs with the 30 largest Globally Systemically Important Banks (GSIBs). The VBBs – all GABV members – operate in numerous markets, serve diverse needs and use distinct business models but share a common strategic foundation: the Principles of Values-based Banking. A few of the 37, such as US-based First Green Bank (main picture, above) are only analysed for part of the period, primarily because they are start-ups that don’t have financial performance data for the full range of years.
VBBs are grounded in the real economy – in other words, in economic activities that generate goods and services as opposed to a financial economy that is concerned exclusively with activities in the financial markets. The real economy is centred on enterprises and individuals that place people before profit, and focus their resources on activities that deliver economic resilience, environmental regeneration and social empowerment for the communities and people they serve.
The distinction is reflected in the fact that the levels of lending by VBBs is nearly double that of GSIBs. It is core to their activities, constituting over 75% of their balance sheets compared to just over 40% of the balance sheets of GSIBs. VBBs also rely much more on client deposits to fund their balance sheets in comparison with GSIBs (81.6% versus 53% in 2016).
VBBs have had a better Return on Assets (RoA) over the last five years than GSIBs and slightly better or comparable Returns on Equity (RoE), with less volatility over both the last five and ten years. VBBs have also had much higher relative growth in loans, deposits, assets, equity and total income compared to GSIBs over the periods analysed.
“The number one reason for taking the biggest banks in the world is because this is a peer set that is externally defined,” says David Korslund, the GABV’s chief economist and the lead author of the research. Another reason is the emphasis that these banks always put on shareholder value. “They may say that but the proof is in the pudding… because they actually don’t provide superior returns.”
The largest banks had enormous support from governments and regulators during the financial crisis, Korslund points out, but they are not using that to support the real economy. One thing they are doing well is paying their highest earning staff. He cites recent analysis by the FT that showed that between 1995 and 2016, Deutsche Bank shareholders earned a net €17bn, while over the same period the bank paid bonuses of €71bn.
The GABV is now planning deeper research. Korslund says there is some work that has not yet been published looking at banks in the US, which shows “an almost perfect correlation” between performance and those with good capital positions that are most focused on the real economy. The GABV would also like to look at the financial returns of a variety of banks that would be more aligned, in terms of size, with the VBBs than the GSIBs.
The GABV institutions have mostly consistent performance across the years, says Korslund, but it is no surprise that the European players are typically less profitable than their emerging market peers. Nevertheless, within the report, the GABV has done some specific European bank comparisons, which doesn’t make the GABV members look too bad at all, he says. The commercial bank GABV members tend to have higher returns than the credit unions, with the client-ownership of the latter influencing their priorities, as reflected in the interest rates that they set for deposits and loans.
When comparing performance, there is also the question of whether it is feasible to quantify the non-balance sheet aspects – basically, whether a bank is hurting, meeting or helping the wider economy and society. There are some challenges to capturing this, accepts Korslund, but there are clearly defined sustainability objectives that could be used.
So why isn’t ethical banking more common?
The answers to this question cited by the GABV include inertia and the power of the status quo, including existing personal incentive structures; a lack of courage and innovation by banking executives and shareholders to change course; and limited awareness of the benefits, such as highlighted by this type of research.
Even start-ups seldom adopt ethical banking as a differentiator. In the UK, where the government has proactively encouraged new entrants in the last decade, they are largely an uninspiring bunch and look a lot like the banks that were already in the market (perhaps in part because most of the founders came from the existing banking sector).
Korslund offers some words of hope. “I believe there is momentum to find new banking business models.” Indeed, some of the incumbents are now aware that their current business models fundamentally no longer work. “I hope that one, two, three, four or more larger banks start taking sustainability more seriously because they see it as a good business proposition.” He cites Canada-based Vancity, which has Can$21bn in assets, as a bank that has been on this sort of journey, joining the GABV in 2010 and now dedicated to values-based finance.
He believes the Dutch and Nordic markets might be places to look for such converts, so too spin-offs from big banks or existing banks that are so troubled, such as RBS, that they take a different direction.
The conversion of existing large banks would be significant from a scale perspective, Korslund feels, because although start-ups are important and there need to be more of them, their impact is limited. “Even if Triodos Bank grew consistently by 25% per year for ten years, it still would not be among the largest banks in the world.” This is despite the fact it is a well-established and relatively large bank compared to most of its fellow ethical counterparts.
Hopefully the messages from the GABV and the individual members are falling on ever more fertile ground. Korslund feels investors and shareholders need to put more pressure on the established banks to change their ways. Having – as they all do – slick corporate responsibility statements isn’t enough. Where a relatively small number of banks today follow a truly ethical, real economy-based model, hopefully whether through choice or necessity, others will follow.
For further reading, the GABV has recently published an e-book entitled “Where Money Moves Matters” to complement the research and, in the GABV's words, "puts a face to the numbers". It tells some of the success stories of its members supporting in supporting often the most vulnerable people in society.