Companies do not produce profits, they produce shoes
Are new financial practices showing the way forward? Bloomberg presenter Judith Bogner moderated a panel at the Luxembourg Financial Forum (3rd June) that started where an earlier panel left off: if you cannot regulate stupidity what model can you adopt to ensure that financial services are sustainable in themselves and deliver sustainable results?
Raja Teh Maimunah, a former investment banker now responsible for Islamic finance at the Malaysian stock exchange, described how the three basic principles of Islamic finance – no interest, no gambling and no uncertainty - underpin a model in which banks and their clients are equity partners and share risk. “If conventional banks had followed these principles we might have avoided the Western Financial Crisis” she argued, adding “The BAFIN ban on derivatives trading in Germany is basic Islamic finance.”
An alternative role model for sustainable finance can be found in microfinance. Speaking for Grameen bank of India, a pioneer in microfinance, Royston Braganza explained why that industry had been protected from the effects of financial crisis. Grameen makes small non-collateralised loans to poor people to enable them to set up a profit generating activity. Clients are grouped into mutually guaranteeing support groups and are educated in managing their loans and their businesses. The bank fosters social inclusion (loans are made to the old, the young and especially to women) and profits are ploughed back into the industry so as to be able to reach more clients. Here, in three sentences, is everything that the sub-prime lenders should have been doing and weren’t. Moreover the growth potential for the sector is huge. In India alone, reported Braganza, microfinance is only meeting 10-15% of demand.
Richard Pelly of the European Investment Fund brought the microfinance model closer to home. EIF is a generous supporter of microfinance within Europe. Pelly agreed that there was no doubt about the role of microfinance in sustainability (“this is the basic business of banking”) but he added that there was a question with regard to the sustainability of individual microfinance institutions. Rapid expansion was taking its toll and in Europe the financial crisis had had an impact on loan performance. The funding gap is also large, while available capital is not always allocated efficiently.
The key to sustainable finance: take responsibility
Erol Bilecen of Bank Sarasin defended the traditional institutional investment and private banking model. “The bank has existed for 170 years” he commented “and for most of this time it was a partnership with unlimited liability”. The point was not lost on the audience. “High net worth clients are looking for their bank to take responsibility” he said, and went on to report on how the bank, in the early 2000s, had switched all its investment portfolios to a sustainable model. Less than 5% of clients had rejected the move. As a direct consequence of this policy, the bank had not experienced a single default in its investment portfolios as a result of the financial crisis. “It’s not a question of right and wrong” he explained “there are business models that are simply higher risk than other industries. With our fiduciary responsibility we choose not to invest in them”.
Lord Hastings of KPMG was able to draw on a variety of client histories from around the world, demonstrating that it was possible to reduce a company’s carbon footprint and contribute to projects that push forward best practice. Investors should go where the smart money is, he said, “the biggest growth area is in sustainable technology.” Money freed up from investment in out of date, capital intensive industry could be recycled into developing markets, creating a virtuous cycle. However, for this to happen, he added “we have to be prepared to change our lifestyles”. Hastings quoted the ban on public smoking as an example of how this was achievable.
Having laid out their stalls, a lively debate ensued on which ideas could be applied to the financial sector as a whole.
“Tell them to go to Las Vegas!”
Raja Teh Maimuna pointed out that trading credit derivatives creates no wealth or employment – just profits for the few – and regretted that capital adequacy rules are skewed against responsible investment. “Basel 2 doesn’t like Islamic banks” she reported, requiring them to have huge capital adequacy ratio because their capital is invested in joint venture projects. “Risk sharing makes you careful” she pointed out. “Western banks take your money and gamble with it … so they require less capital!”.
Raja Teh also stressed that banks must learn to say no to unreasonable client requests. “If a client asks for a 20% yield the bank creates a structure that yields 20% - but it’s not sustainable! Tell them to go to Las Vegas” she joked.
Unlearning 400 years of bad practice
Lord Hastings pointed out that the principles behind Islamic finance are classical Judeo-Christian values that were abandoned in the sixteenth century in favour of practices that generated more immediate profit. The challenge is how to relearn these principles. Doing business around a values based business model will be fundamentally new.
There is however no choice, he continued. “6.5 billion people cannot live on this planet with the lifestyle of the top 2 billion”. Nor can a projected population of 9 billion “This would take the resources of four planets … We must be ready for a lifestyle transformation.”
Royston Braganza pointed out that microfinance could show the way forward for entrepreneurs and company analysts. “Create a business but don’t look to make a huge profit out of it” he recommended; if the business is sustainable, it will make a profit for you. Erol Bilecen agreed, citing Peter Drucker the management theorist: “Companies do not produce profits, they produce shoes.” He added that you cannot get away from the triangular law of investment: “safety, liquidity, yield: you cannot have them all at the same time”.
Bankers can resist everything except temptation
Raja Teh advocates legislation on the grounds that the profit motive is just too tempting, “but you cannot gamble with the lives of millions” she said. Lord Hastings added weight to this moral argument, quoting the World Bank’s announcement that the financial crisis had added 120 million people to the 2 billion already living under the poverty line.
Erol Bilecen summed up the debate, referring back to the behavioural debate of the first panel, in which delegates had discussed the effects of the animal brain on human social behaviour. “We must adapt or perish” he concluded. ER