You are on page 1of 33

Trust and Integrity in

Banking
John R. Boatright
Loyola University
Chicago, USA
ABSTRACT. No one disputes that trust and integrity are
important in banking, but it is more difficult to delineate
clearly what trust and integrity mean with regard to
banking and what role they play. Toward this end, I explain,
first, how the distinctive features of banking, which
differentiate this activity from other kinds of business,
create a particular need for trust and integrity. Despite this
need, however, I caution against placing too much reliance
on morality or ethics as a means of ensuring the proper
functioning of the banking system at the expense of other
important factors, which include market forces, government
regulation, and institutional design. Finally, I describe some
of the implications for trust and integrity from the changed
nature of modern banking, which I identify as the division of
the value chain, the new business as usual, and the
phenomenon of financialization.
KEYWORDS. Trust, integrity, banking, regulation, institutional
design, financial- ization

I.

INTRODUCTION

rust and integrity are highly valued moral goods,


not only in banking but in business generally. Indeed,
little commercial activity would be possible without
them. Moreover, many scandals and crises, including
the current financial collapse, are blamed on the lack of

trust and integrity. In discussing these matters,


however, it is all too easy to invoke pious platitudes
about the need for trust and integrity in banking and to
make earnest appeals for a restoration of these
qualities. A more rigorous treat- ment of the subject,
however, would address questions about what is
morally required of bankers and why these
requirements arise. Banking is

ETHICAL PERSPECTIVES 18, no. 4(2011): 473-489.


2011 by European Centre for Ethics, K.U.Leuven. All rights reserved.
10.2143/EP.18.4.2141844

doi:

ETHICAL PERSPECTIVES

DECEMBER

2011

different from other business activities in morally


relevant ways, and so we must consider the distinctive
roles that trust and integrity play in banking.
In addressing such questions, we must deal with the
fact that banking has changed significantly during the
past few decades. The world of banking in the twentyfirst century bears little resemblance to what it was,
even as recently as 1980. As Laurence J. Kotlikoff
observes in his book Jimmy Stew- art Is Dead (2010),
the kind of banking described in the classic movie Its a
Wonderful Life no longer exists. Kotlikoff suggests that a
movie about bank- ing today might be titled Its a
Horrible Mess. Even if this view is unnec- essarily
harsh, it is evident that modern banking has produced
an unusually severe crisis and threatens to repeat its
mistakes again and again. The failures in the banking
system are not due solely to a loss of integrity and trust,
and their restoration would not solve all the problems.
However, trust and integ- rity are still important in
modern baking. So I propose to examine what trust and
integrity mean in this new world of banking and what
role they play.

II.

HOW BANKING

IS

DIFFERENT

FROM

OTHER BUSINESSES

I begin by identifying some features of banking that


make it different from other businesses and business
activities. Although banks are busi- nesses, their
distinctive character is evident in many ways, including
how they are chartered, governed, regulated, and
operated. Being a banker is commonly considered a
474

Ethical Perspectives
18 (2011) 4

JOHN R. BOATRIGHT TRUST

AND

INTEGRITY

IN

special
role that invites admiration, as well as some
BANKING
suspicion and resentment. And the banking system is
generally con- ceived as both a necessity for an
economy and a danger to society. Indeed, Thomas
Jefferson is said to have commented, that banking
establish- ments are more dangerous than standing
armies. What is it about bank- ing that accounts for
these differences from other business pursuits?
One distinctive feature of banking results from its
unusual status with respect to markets. In capitalist
systems, markets are the main venue for economic
activity; they are the arenas in which buyers and
sellers exchange

Ethical Perspectives
18 (2011) 4

475

goods and firms engage in production. A key element of


markets is the use of contracts as the chief device
for executing discrete transactions. Contracts have the
important moral property that they do not depend for
their force on trusting the other party. With legally
enforceable contracts, we can engage in exchanges or
transactions with anonymous parties with the
confidence that they will perform as expected. In the
absence of a well- functioning legal system, however,
with unreliable contract enforcement, trust becomes
critical. Indeed, trust can be understood as an
alternative to legally enforceable contracts as a means
for engaging in market activity. That is, we must trust
others in situations where reliable contracting is not
feasible. The same point applies to the concept of
fiduciary duty, which is of critical importance in
banking. Fiduciary duty is explained, by some, as a
device for filling gaps in incomplete contracts (see,
for example, Hart 1993; Macey 1999). In corporate
governance, for instance, an officer or director owes a
fiduciary duty to shareholders but not to any other
group. One explanation for this single-minded focus is
that every other group participates in the productive
activity of a firm by means of complete, legally
enforceable contracts. Thus, employees, suppliers, and
debt capital providers secure a return on their various
inputs by using contracts that do not depend for their
force on any duty that is imposed on the firms
managers. These groups relate to a firm solely through
a market. Share- holders, by contrast, cannot write
complete contracts with the firm that specify in detail
how officers and directors should behave. The solution

to this difficult contracting problem is to impose a


fiduciary duty that obliges management to use
shareholder interest as the objective in all decision
making. According to this view, imposing a fiduciary
duty is a
second-best solution to a problem of incomplete
contracting.
Traditional banking is conducted to some extent in
a market through contracting, but banks are not
market actors in the same way that a gro- cery store,
for example, buys food from suppliers and sells it to
custom- ers in arms-length economic exchanges or
transactions in a market. Nor does a bank resemble a
manufacturer that purchases inputs in a market

from suppliers, including labour and capital, and


transforms them into an output in the form of a
product that is sold to customers. What, then, do
traditional banks do?
Traditionally, banks served as intermediaries in
fulfilling four critical func- tions in an economy: (i)
payments, providing a means for transferring money
from one party to another; (ii) savings, providing a
means for people to safely place money that is not
needed for current consumption; (iii) lending, making
loans from savers deposits to customers in need of
funds for consumption or investment purposes; and (iv)
risk bearing and risk shifting. In particular, banks bear
the risk involved in using savers deposits to make loans
to bor- rowers and shift the risk from depositors to the
banks shareholders.
The service that banks provide in the payments
system is largely a contractual fee-for-service business,
although customers and recipients must trust that this
service will be performed reliably and properly. Lending, too, is largely governed by contracts insofar as
loan agreements spec- ify the obligations of each party
and, in particular, of the borrowers to repay the loan
with interest. In the lending function, banks are the
vulner- able party that must trust borrowers to repay,
although the need for trust is reduced when a loan is
secured by collateral and a legal right to fore- close is
available. Trust is critical primarily in the relationship
of savers or depositors and the bank to the extent that
the money in question must be kept secure in the loan
process and made readily available to be returned on
demand. In this process, a bank serves as an
intermediary between savers and borrowers, not only

in facilitating the conversion of savings into loans but


also in assuming the risks involved. These risks include
the risk of default by the borrower and the risk of a
bank run due to the maturity mismatch that results
from lending savers short-term deposits to long-term
borrowers. However, both of these risks are shifted
away from the bank by deposit insurance, which
reduces the need for trust in banks because a
government not only insures depositors savings but
also assumes a monitoring role. With deposit
insurance, savers trust in government reduces the
need to trust banks.

The need for trust in banking can be understood


by conducting a thought experiment similar to the
question posed by Ronald Coase about firms (1937). He
asked why all economic activity could not take place
entirely in markets. That is, why do firms exist at all if
markets are so effective? His famous answer was that
firms economize on transaction costs. Similarly, we can
ask whether all the functions of banking could be
carried out in discrete market transactions. Why is
contracting not sufficient to accomplish all the tasks of
banks? One answer is that banking is a continuous
activity in which customers and banks establish
relationships that last over time rather than engaging in
discrete, one-time transactions. Many aspects of these
relation- ships cannot be specified in contracts but
depend on trust. More signifi- cantly, banking is not a
bilateral relationship between just two parties, but is a
coordination activity among multiple parties. In theory,
borrowers could approach a large number of savers and
contract collectively with each one to borrow some of
the funds needed. However, not only would the transaction costs of this activity be very high, but also two
important benefits of banks could not be achieved.
First, there is no way, even in theory, for the savers to
loan money for a fixed period of time and also have it
available for return on demand. Second, the savers
could not loan the money without bearing the risk of
default. Thus, banks serve an intermediation role that
could not be achieved by contracting without them
and, hence, without some degree of the trust that
relationships, rather than transactions, require. A
second distinctive feature of banking is that it does

not merely provide services and products in a


functioning economy; it is an essential component of
an economy that enables it to function. The banking
sys- tem has been compared to the heart in a body,
which circulates blood throughout the body and
thereby sustains life. Just as a body could not function
without a heart, so an economy cannot function
without a bank- ing system. This reliance of an
economy on a banking system has led some
commentators to speak of banking as a utility. Mervyn
King (2009), the Governor of the Bank of England,
recently called for a separation of
utility banking and what he labelled casino banking.

This utility aspect of banking creates another role


for trust: to assure everyone that the essential services
and products of the banking system will be maintained.
We must trust bankers in the same way that we trust
the leaders of basic utilities to keep the lights on and
the water and gas flowing. However, unlike these
utilities, which merely provide generic commodities,
banks are privy to a great deal of sensitive information,
which, in fact, gives rise to the importance in banking
of duties related to confidentiality and privacy and the
trust that these duties require.

III.

WHY TRUST

AND INTEGRITY ARE

NOT ENOUGH

I have offered in these remarks an account of why trust


and integrity are essential to traditional banking for
reasons that do not apply to conven- tional businesses.
In this account, I have assumed that in a market with
legally enforceable contracts there is little need for
these moral goods, and that their need in banking is
due to the non-market character of this activ- ity. Of
course, all markets require some degree of trust, and
they flourish only with an abundance of it. Adam Smith
argued that trust is necessary not only for economic
exchanges to occur but also for the existence of
property rights and capital formation, which are the
building blocks of a market economy. Francis
Fukuyama (1995) observes in his book Trust that trust
is also essential for the development of social capital.
Fukuyama admits that markets are possible without
much trust, but he writes that people who do not trust

one another will end up cooperating only under a


system of formal rules and regulations, which have to
be negotiated, agreed to, litigated, and enforced
(1995, 27). All of these create high trans- action costs.
He further observes, Widespread distrust in a society
[] imposes a kind of tax on all forms of economic
activity (1995, 27-28).
Despite these undeniable economic benefits of trust
and integrity, I con- tend that they are not unalloyed
goods that we should unreservedly empha- size and
encourage, especially to the exclusion of more effective
means to

the same ends. Trust and integrity, as well as morality


generally, have two crucial limitations. First, they are
difficult and costly to inculcate. Extensive social
resources must be expended to ensure that all
individuals in society or an institution, such as a bank,
are trustworthy and always act with integrity. These
moral goods are part of social capital, which, as
Fukuyama observes, is different from financial capital
and human capital in that it cannot be cre- ated merely
by financial investment; it can only be acquired, like the
virtues, from habituation to the moral norms of a
community (1995, 26). Fostering this habituation, no
matter how desirable it is, requires a considerable commitment by society and its major institutions. Second,
trust and integrity, along with morality generally, are
unreliable. Trust can easily break down or prove
illusory, and even people with integrity can sometimes
act wrongly. If our goal is to ensure that banks and the
banking system operate well, it would be prudent to
examine all the means available for this purpose.
What other means are available? In broad outlines,
there are four major means for ensuring that banks
operate well and fulfil their main functions. These are
market forces, government regulation, institutional
design, and ethics or morality. First, with respect to
market forces, com- petition among banks for
customers deposits and loan business provides banks
with powerful incentives to assure these customers of
their trust- worthiness and integrity. Banks compete
with each other over virtually every service they
provide to the public and to corporate clients, not only
on price and performance but also on reputation, as
each bank seeks to enhance this intangible factor to

achieve a competitive advantage. Ingo Walter (2010)


has shown that the cost of a damaged reputation can
be immense, and so banks have a strong incentive to
manage reputational risk. Although the market for
banking services is less than perfect due to increasing
concentration of the industry, enough competition
remains for the market to be a powerful disciplinary
force.
More generally, economists have demonstrated how
perfect markets can solve many coordination problems,
such as, in the case of Ronald Coase, the problem of
social costs or externalities (1960). Indeed, the

philosopher David Gauthier (1986) has argued in his


book Morals by Agreement that in perfect markets,
there would be no need for morality at all because all
transactions would take place by mutual consent or
agree- ment. Second, banks have long been subject to
close government regula- tion, which is due not only to
deposit insurance but also to the necessary role of
government in the currency and credit systems. Unlike
most busi- nesses, where regulation serves mainly to
protect the public, banking could not easily exist
without close association with government. Third,
economists, such as Douglass North, have explained
the importance of the design of institutions in
advancing economic development and chan- nelling
market activity (1990). Trust and integrity can be
facilitated, for example, by the governance structure of
banks (such as partnerships ver- sus public ownership);
by the separation of functions (such as commercial
from investment banking, of banking from insurance,
and mortgage orig- ination from securitization); and by
organizational features (such as the shielding of
analysis from bank lending and the compensation and
bonus structures). In banking, institutional design
matters, and many problems can be solved by getting
the design right.
Finally, ethics or morality is a major factor in
guiding and controlling human behaviour, which
operates in banking and other economic activity not
only by providing an internal motivation for right
action but also by means of formal codes and
compliance programmes. For example, an individual
banker may be guided in making a right decision not
only by a personal conception of right and wrong or

an internal moral compass, but also by consulting a


banks code of ethics, mission statement, or other
policy documents. It is not my intention to minimize the
role of ethics or morality in banking but to stress two
points. One is that ethics or morality is not the only
factor in guiding behaviour. Markets, government
regulation, and institutional design are non-exclusive
alternatives that should be combined with ethics or
morality to form an effective deter- rence and control
system. The second point is that ethics or morality has
limitations as a means of deterrence and control. As
part of a complete

system, it is difficult and costly to implement and is of


uncertain reliabil- ity. President Ronald Reagan
frequently said in connection with arms control and the
Soviet Union, Trust, but verify. This phrase emphasized the point that trust alone is inadequate and is
best combined with other means of assurance. Indeed,
the best system might be one that does not require
much trust at all.
As a moral philosopher, I have a personal incentive
to promote ethics as much as possible. However, I think
it is important not to see a moral problem where none
exists or to propose moral solutions where they are
inappropriate. Sociologists use the word moralization
to denote the identify- ing or classifying of phenomena
as moral in character or as having a moral dimension.
Thus, to criticize the role of the mortgage origination
process in the current financial crisis as the failure of a
moral duty or obligation is to engage in moralization. In
this example, I think that the mortgage originators who
extended mortgages to unqualified borrowers acted
wrongly, so that conceiving of this case in moral terms
is wholly appropriate. About other possible examples in
the current financial crisis, such as the securitization of
mortgages, I am less sure. The challenge of
moralization, then, is to use it properly by correctly
identifying situations in which morality is involved and
by correctly analyzing the exact nature of the moral
elements or factors.
A caution against moralization is provided by what
has been called Hanlons razor: Never attribute to
malice that which can be adequately explained by
stupidity. To this, Douglas W. Hubbard has added:
Never attribute to malice or stupidity that which can

be explained by moderately rational individuals


following incentives in a complex system of interactions (2009, 55). The challenge, then, in analyzing the
role of trust and integrity in banking or the current
financial crisis is to separate out the roles played by
malice, stupidity, moderate rationality, and perverse
incen- tives in a complex system of interactions. To
correct the failings that arise in banking and our
financial system generally, we need the opposite of
these, namely virtue, wisdom, and better markets,
regulation, and institu- tional design. Trust and
integrity are included in virtue, although they are

also a part of wisdom as understood by Aristotle in the


form of phronesis or practical wisdom. We need
bankers who are virtuous and practically wise, in
Aristotles sense, but we also need better markets,
regulation,
and
institutional
design
and
an
understanding of how all these elements should be
balanced and fitted together.

IV. HOW

CHANGES

IN

BANKING IMPACT TRUST

AND INTEGRITY

So far, I have made two main points. First, I have


shown why trust and integrity are essential to
traditional banking, and second, I have cautioned
against placing too much stress on these moral
elements in favour of a more comprehensive view of all
the factors involved in assuring the suc- cess of
traditional banking. I turn now to the fact that banking
has changed significantly in the past few decades so
that traditional banking no longer exists in the form it
once did. If, as Kotlikoff says, Jimmy Stewart is dead,
what are the implications of the changed nature of
bank- ing for our analysis of trust and integrity?
Banking has been transformed recently by three
interrelated develop- ments. The first is that banking
has experienced a division of the value chain, in
which different banking functions are now being split
up among many different special purpose institutions.
Once banks had an effective monopoly as the main
place for saving and lending, but today savers have
many more options, most notably money market and
mutual funds and personally-owned pension funds.
With respect to lending, consumers can obtain

automobile loans from special purpose finance


companies, and business loans are readily available
from specialized commercial lenders. The home
mortgage market has become the province of separate
com- panies which originate loans that are sold to
arrangers, which, in turn, package them into securities
for sale to investors around the world. Con- sequently,
banks now hold a much reduced share of savers
deposits and borrowers loans, with the lost business
now being assumed by a wide variety of specialized
financial institutions.

Second, the banking industry has been increasingly


consolidated by mergers and acquisitions (some forced
by failures) into a small number of very large,
comprehensive megabanks that offer all manner of
services under one roof. Since some of these services
are more profitable than others, the focus in these
banks has shifted to the few services that are the most
lucra- tive. In recent years, banks have relied for profits
more and more on devel- oping securities, such as
collateralized debt obligations (CDOs) and special- ized
derivatives, and on trading for their own account,
usually leveraging their capital by borrowing short-term
to finance their large portfolios. As Simon Johnson and
James Kwak observe in their book 13 Bankers:
For Wall Streets megabanks, business as usual now
means inventing tradable, high-margin products,
using their market power to capture fees based on
trading volume; taking advantage of their privileged
mar- ket position to place bets in their proprietary
trading accounts; and borrowing as much money as
possible (in part by engineering their way around
capital requirements) to maximize their profits
(2010, 193).

The third development is one commonly called


financialization, in which finance has come to assume
an increasingly important role in peoples lives as the
major source of their well-being and security. In his
Managed by the Markets: How Finance Re-Shaped
America, Gerald F. Davis observes that peoples
welfare, which was formerly secured by organizations,
usu- ally a corporate employer, is now sought in
financial markets. He writes:

As large corporations have lost their gravitational


pull on the lives of their members, another orienting
force has arisen: financial markets []. The bonds
between employees and firms have loosened, while
the economic security of individuals is increasingly
tied to the overall health of the stock market (2009,
3).

People not only depend more on finance for the


sustenance of their lives but have had their thinking
shaped by it to produce what Davis calls the portfolio
society. Quoting further:

As financial markets extended their reach beyond the


corporate world, more aspects of social and political
life were drawn into their rhythm []. What emerged
can be called a portfolio society, in which the
investment idiom becomes a dominant way of
understanding the individuals place in society.
Personality and talent become human capital, homes,
families, and communities become social capital,
and the guiding principles of finance spread by
analogy far beyond their original application (2009,
6).

These three developments the division of the value


chain, the new business as usual, and financialization
or the portfolio society have significant implications
for trust and integrity.
First, financial activity has come to consist more
and more of imper- sonal transactions among
anonymous parties in complex systems. Banks still play
a vital role in the system, but they are no longer
vertically-inte- grated institutions that control every
function in a long value chain. Rather, they carry out
specialized roles in this chain. In this transition from
relationships with banks to impersonal transactions
among anony- mous parties in complex systems, we
have come to rely less on trust in individual institutions
and more on trust in the system itself. Every finan- cial
institution has a duty or obligation not only to perform
its specialized functions well and reliably, but also to
maintain the trustworthiness and integrity of the whole
system. However, in this system, trust and integrity as
traditionally conceived play less of a role due to the
impersonal character of the transactions. Banking is
similar in this respect to air flight, which today depends

as much on the guidance and control systems of the


aviation industry as it does on the skill and judgment of
individual pilots.
In situations where trust is placed more in the
whole system than in specific people or institutions,
individual responsibility is not diminished; indeed, it is
needed more than ever. However, the trust that we
place in people and institutions extends beyond their
performance of traditional banking functions and
includes their responsibility to build and maintain the
whole financial system. What is morally required from
bankers today, then, is a sense of responsibility for the
role that they and their own

institutions play in the functioning of the larger


financial system. I trust the banks I deal with to handle
my payments and keep my money secure. That is, I
trust them to carry out the traditional functions of
banking. What I trust less is their awareness of their
responsibility to build and maintain the integrity of the
entire financial system and their commitment to fulfil
this responsibility.
Second, with the rise of megabanks engaged in the
production of large volumes of complex securities and
derivatives and in highly-lever- aged proprietary
trading comes considerable systemic risk. This risk is
exacerbated by the implicit subsidy that large banks
receive by being per- ceived as too big to fail since
investors believe, rightly or wrongly, that the
government will come to their aid in the event of
distress. The result is a substantial moral hazard
problem. In addition to posing a systemic risk for
society, which is exacerbated by moral hazard, banks
are also engaging in a shifting of risks that they
formerly assumed. For example, adjustable-rate
mortgages shift some of the credit risk due to interestrate fluctuations back to borrowers, and CDOs shift the
entire risk of a loan portfolio from banks to the
ultimate investors who purchase these secu- rities.
Credit default swaps shift the risk of loans from the
holders to the firms issuing the swaps and, ultimately,
to taxpayers if the issuing firms fail, as in the case of
AIG. This risk shifting by banks is only a part of a much
larger phenomenon of major institutions abandoning
their tradi- tional risk-bearing role, which is described
by Jacob Hacker (2006) in his book The Great Risk
Shift.

In view of the systemic risk that too-big-to-fail


megabanks pose, the responsibility of bankers now
includes a careful evaluation of how their actions bear
on systemic risk. Traditionally, bankers have
considered only the specific risk that threatened the
survival of their own institution and assumed that
protection against systemic risk, if necessary, was the
responsibility
of
government
regulators.
The
underlying assumption was that concern over systemic
risk was unnecessary because self-interest would
prevent banks from taking risks that posed too great a
threat even

to their own survival. This assumption was shattered in


the recent finan- cial crisis, as witness the comments of
Alan Greenspan in testimony before Congress: Those
of us who have looked to the self-interest of lending
institutions to protect shareholders equity myself
especially are in a state of shocked disbelief
(Andrews 2008). Given the falsity of this assumption
about the power of self-interest to self-regulate,
bankers have a responsibility to assess the contribution
that their bank is making to systemic risk that affects
the whole of society and not merely their own
shareholders. Put starkly, we should be able to trust
bankers not to destroy the whole economy.
Since banks also play a valuable role in bearing risk
and can have an impact on society by shifting risk to
other parties, it is also incumbent on bankers to
recognize their responsibility for the allocation of risk
and to carefully assess what risks are assumed and
shifted. Ideally, risks should be borne by the parties
that can bear them most efficiently, and some recent
risk shifting may be due to this search for efficiency.
For example, securitization, which transfers the risk of
loans from a bank to large inves- tors, could, if done
correctly, result in more efficient risk bearing. However, in the recent financial crisis, the default risk of
loans packaged in CDOs was shifted to parties that did
not understand the risks and con- sequently mispriced
them. The standard assumption is that it is permissible to shift risk as long as the accepting party
consents. Lloyd Blankfein, also in testimony before
Congress, defended Goldman Sachss shorting of
securities it had sold by saying that it was dealing with
sophisticated, professional investors who want this

exposure (Sorkin 2010). Appar- ently, the willingness


of investors to buy securities, no matter how toxic they
may be, absolves Goldman Sachs of any responsibility
for losses. However, I maintain that this is an
unacceptable position: we should be able to trust
bankers to shift risks responsibly.
Third, financialization or the portfolio society
creates a responsibil- ity on the part of the financial
services sector to provide products and services that
truly fit peoples needs. This has always been true, but
the

responsibility has become more urgent if, as Davis


claims, financial mar- kets have replaced organizations
as the main source of peoples welfare and security.
With a fraying welfare safety net in Europe and the
United States, people are looking more to the financial
sector than to either employers or government for
support. It is debatable whether banking has
responded appropriately. Much financial innovation
seems to be more focused on what makes profit for the
banks shareholders than on the good of the people
banks claim to be serving. The New York Times
columnist and Princeton economics professor Paul
Krugman has written that it is hard to think of any
major recent financial innovation that actu- ally aided
society, as opposed to being new, improved ways to
blow bub- bles, evade regulation and implement de
facto Ponzi schemes (2009). Paul Volckers, a revered
former Federal Reserve Board chairman, has opined
that the only useful recent financial innovation was the
ATM machine (Hosking and Jagger 2009). If we now
must trust bankers more to provide the products and
services that are essential to our welfare and security,
then they must earn that trust by taking greater
responsibility for the implications of financialization or
the portfolio society.

V.

CONCLUSION

In an effort to get beyond pious platitudes and earnest


exhortations about trust and integrity in banking, I
have endeavoured to explain how tradi- tional banking

is different from other businesses. First, since banking


cannot be conducted solely by bilateral market
contracting but serves an intermediation function
between multiple parties, trust and integrity are
requirements. Second, the utility character of banking
also creates a need for trust due to the dependence of
the economy on banking services. However, despite the
need for trust and integrity in banking, I have also
cautioned against placing too much reliance on
morality or ethics as a means of ensuring the proper
functioning of the banking system. In order

to avoid the problem of moralization, we need to find a


workable balance between market forces, government
regulation, institutional design, and morality as means
for controlling banking activity. Finally, I have
attempted to describe some of the implications for
trust and integrity arising from the changed nature of
banking. Modern banking, as opposed to the traditional
form, has been transformed by the division of the
value chain, the new business as usual, and
financialization or the emergence of the portfolio
society. Each of these changes alters and expands the
responsibilities of bankers in significant ways.
In the United States, a suspicion of banking has
existed from the time of its founding, and resentment
over periodic banking crises continues to undermine
trust. Many critics of modern banking warn that crises
will continue unless drastic action is taken, especially
with regard to the banks that are too big to fail.
Opinion differs on what to do. Some, such as Joseph
Stiglitz (2010), argue that the big banks should be
broken up and their activities restricted; others, such
as Mervyn King (2009), recommend separating utility
and casino banking. This is echoed by the advocates of
limited purpose banking, which is essentially a return
to the banks depicted in Its a Wonderful Life. The
prevailing sentiment in the United States, so far, has
been simply to impose more stringent regulation
2300 pages of it in the Dodd-Frank Act! Whatever the
outcome of this debate, it is evident that the challenge
of restoring trust and integrity in banking is as difficult
as it is necessary.

WORKS CITED
Andrews, Edmund L. 2008. Greenspan Concedes Error on
Regulation. New York Times,
October 23.
Coase, Ronald H. 1937. The Nature of the Firm. Economica N.S.
4: 386-405.
Coase, Ronald H. 1960. The Problem of Social Cost. Journal of
Law and Economics 3: 1-44. Davis, Gerald F. 2009. Managed by
the Markets: How Finance Re-Shaped America. New York:
Oxford University Press.

Fukuyama, Francis. 1995. Trust: The Social Virtues and the


Creation of Prosperity. New York: Free Press.
Gauthier, David. 1986. Morals by Agreement. Oxford: Oxford
University Press.
Hart, Oliver. 1993. An Economists View of Fiduciary Duty.
University of Toronto Law Journal 43: 299-313.
Hacker, Jacob S. 2006. The Great Risk Shift: the Assault on
American Jobs, Families, Health Care, and Retirement and How
You Can Fight Back. New York: Oxford University Press.
Hosking, Patrick and Suzy Jagger. 2009. Wake Up, Gentlemen,
Worlds Top Bankers Warned by Former Fed Chairman. The
Times, December 9.
Hubbard, Douglas W. 2009. The Failure of Risk Management: Why
Its Broken and How to Fix It. New York: Wiley.
Johnson, Simon and James Kwak. 2010. 13 Bankers: The Wall
Street Takeover and the Next Financial Crisis. New York:
Pantheon.
King, Mervyn. 2009. Speech by Mervyn King, Governor of the
Bank of England, to Scottish Business Organizations,
Edinburgh on Tuesday 20 October 2009. http:// www.bankof
england.co.uk/publications/speeches/2009/speech406.pdf
[accessed September 9, 2011].
Kotlikoff, Laurence J. 2010. Jimmy Stewart Is Dead: Ending the
Worlds Ongoing Financial Plague with Limited Purpose
Banking. New York: Wiley.
Krugman, Paul. 2009. Money for Nothing. New York Times, April
26.
Macey, Jonathan R. 1999. Fiduciary Duties as Residual Claims:
Obligations to Non- shareholder Constituencies from a Theory
of the Firm Perspective. Cornell Law Review 84: 1266-1281.
North, Douglass. 1990. Institutions, Institutional Change and
Economic Performance. Cam- bridge: Cambridge University
Press.
Sorkin, Andrew Ross. 2010. Wall Street Ethos under Scrutiny at
Hearing. New York Times, January 13.
Stiglitz, Joseph E. 2010. Freefall: America, Free Markets, and the
Sinking of the World Economy.
New York: W. W. Norton.
Walter, Ingo. 2010. Reputational Risk. In Finance Ethics: Critical
Issues in Theory and Practice. Edited by John R. Boatright,
103-124. New York: Wiley.