The banking industry throws up an interesting conundrum. Unlike the manufacturing sector it does not naturally cause emissions, however the world of finance impacts almost everything in the modern world. It’s influence on environment, society and communities has to therefore be viewed with a different lens.
Let’s first understand the banking industry. Banks cover four broad verticals. A universal bank covers all, others cover one or more. The four broad verticals are:
Retail: This caters to individuals with limited to reasonable means. Deposits, housing and personal loans, credit cards, insurance etc. are covered here.
Commercial: This caters to small and medium sector enterprises. Its products include working capital loans, project loans, bank guarantees etc.
Institutional: This caters to large institutions as well as high net worth individuals (private banking). Activities are similar to retail and commercial -scale differs.
Markets: The bank trades in stocks. bonds, currency, foreign exchange, commodities. It does so both for its clients as well as on its own (proprietary trading). It also provides research services to its clients, manages M&A deals, supports financing and provides advisory.
A critical ingredient for a bank’s well being is its customers and society. Due to increasing linkages between banks and other parts of the financial system risk moves quickly from banks to their entire financial system. Banks suffer from episodes of failures and economy wide impact. These are more often than not caused by unethical practices, such as those caused by individual bankers that hold the system to ransom or unethical products that lead to the collapse of Wall Street in 2008. The story of collapses keeps repeating itself. Banks need to therefore continually worry about the risks they face. Hence risk becomes an underlying theme for banks.
However, risk and its nature is evolving because the industry too is changing rapidly.
1. Banks are increasing losing their brick and mortar character. With a significant portion of banking activity now being online and on the cloud, security risks are becoming prominent.
2. Payment banks are likely to start operating in India shortly. These would enable smooth transfer of money and increase financial inclusion in the country. Since, these are not “proper” banks material concerns would be around their ability to manage risk and provide a seamless service.
3. The emergence of cyber currencies like Bitcoin is likely to disrupt financial markets. Currently these are issued in the private domain with little backing.This risk is significant but localized to those who are using them. As and when these currencies start getting sovereign backing or countries start issuing their own cyber currency the economic system is likely to be transformed.
Across verticals, the following issues emerge:
Risk management: At risk is the customer’s money and consequently her well-being. Capital adequacy and adequate focus on lending risk will ensure societal well-being. This is critical since banking failures could have a domino effect on the economy. Failures also impose a cost on taxpayers.
Issues: What steps do banks take to minimize risk?
Customer data protection and privacy: This is a critical ingredient of banking. Customer and society’s well-being is at risk here.
Issues: What steps do banks take to minimize loss of customer data?
Sustainable finance/investment: Banks need to be careful of where they lend. Industries that are polluting or cause environmental degradation are prime cases where banks should exercise caution. Banks can play an effective role by binding these companies to targets for improving the environment.
Internally, banks can target areas like paperless banking, reducing carbon emission from power equipment or cash management transportation, operating out of LEED certified (green) buildings, etc.
Issues: How can banks enable companies to mitigate emissions and hazardous waste disposal? What can banks do to reduce their own carbon footprint?
Community engagement: Banks often engage with communities to fulfill their social obligations as an offshoot of the lack of direct impact. Initiatives like customer education, loan waivers and opening bank accounts in remote areas are touted as community services. This is a fine line – most of them end up as a means of either increasing business or are mandated by government.
Issues: How do we distinguish business related actions? What activities should banks undertake to engage with communities?
Anti Money Laundering (AML) : This along with terrorism financing is critical from societal perspective. Banks have to be sensitive to this issue and ensure sufficient controls are in place. Lives could be at stake here. Also, it corrodes the financial system. From banking perspective as well fines by regulators causes diminution of shareholder value.
Issues: How much value do we place on a clean financial system?
Article coauthored with Utkarsh Majmudar and originally published in Economic Times.