Rebuilding Trust In Finance Ten Years After Lehman – Current Perspectives & Why It’s Relevant To Islamic Finance

Blake Goud

A decade on from the Global Financial Crisis, the financial industry has rebuilt trust with barely more than half (54%) of the public across 28 countries surveyed by Edelman. This includes both developed and developing countries across the world including large Muslim-majority countries home to a significant share of the Islamic finance market, among them the UAE, Indonesia, Malaysia, and Turkey. In comparison to technology, which leads business in trust by the broader public, financial services institutions are 21 percentage points behind, though narrowed from a 29 percentage point gap in 2009

For many young people whose economic perspective was shaped by the financial crisis, they have been imbued with a healthy skepticism about business as usual in the financial sector that shapes what jobs they seek and how they save and invest. Building trust with customers will enhance the value they attach to a financial institution’s activities in support of sustainable and inclusive finance. This trust can attract, motivate and help keep talented employees. Shareholders who saw share prices evaporate in the financial crisis want to see financial institutions addressing all of the risks they face.

 

What Millennials Think

Millennials are forecast to inherit $30 trillion over the next 40 years. For the financial industry to thrive, it has to compete to attract Millennials as customers, employees, and shareholders. Each individual is different, but what they share in the post-crisis world is a common desire for business to ‘show me’ what they are doing differently and how they align their business practices to things that millennials and younger people value.

As the wider responsible finance movement commits to improving its practices, financial services institutions should demonstrate their commitment to actions supported by transparency and accountability to rebuild the trust that has been lost. The business risk of not addressing the trust gap comes from many angles: customers, employees, and shareholders, as well as regulators who are keenly aware of the relationship between trust and financial stability.

The financial sector is dependent on the public’s trust and the decisions that each institution makes can have a direct impact on the economy and public trust, but no single financial institution has control over the economy or the public trust.  Mark Carney, then-Governor of the Bank of Canada and now Governor of the Bank of England, speaking about trust in finance in 2013, repeated an adage that “trust arrives on foot, but leaves in a Ferrari” to illustrate how much work is required to build trust and how quickly it disappears when it is lost.

The Financial Crisis was the ultimate example of trust erosion and implosion, which still hangs over the global economy and the financial sector. Ignazio Angeloni, a Member of the Supervisory Board of the ECB reflected on the post-crisis period noting that “This crisis will not be overcome unless and until we somehow restore trust”.

 

New Initiatives

Initiatives emerging from the financial sector, especially those linked to the Sustainable Development Goals (SDGs), aim to transform finance to support the economy becoming more resilient to medium- and long-term challenges such as climate change.  This should be an important way for the financial industry to rebuild trust, yet in many cases, the financial industry does not get full recognition of its contribution. The bonds of trust that would transmit their positive actions into stronger trust have been frayed by the financial crisis which has real-world impacts that include a connection to financial stability.

William Dudley, President & CEO of the Federal Reserve Bank of New York put a fine point on the challenge facing the financial industry when he suggested that “Unless the financial industry can rebuild the public trust, it cannot effectively perform its essential functions”.  This underscores the value that is not always evident in financial industry decision-making about maintaining the public trust. 

Greater public trust in financial institutions provides a margin of safety that creates resiliency during times of stress because it can contribute to a virtuous cycle. When the public has trust and confidence in the financial system, they expect the financial industry to work as a stabilizing force in the economy, which often supports that result.  The financial crisis undermined this cycle: a lack of trust made it much harder for good actions to beget other good actions and makes the relationship between the public, governments and the financial sector more adversarial. 

A few years before the financial crisis, Garry Schinasi who worked on financial stability issues at the IMF wrote in a paper defining financial stability that “Finance existentially embodies uncertainty (about human trust) … [and] provides societies with effective, albeit imperfect, mechanisms for transforming, pricing, and allocating economic and financial uncertainties and risks”.

By lifting some of the uncertainty out of economic transactions between other parties and pricing the risk in a way that can be quantified, the financial industry adds value to society.  To do this effectively, the industry must be competitive but the financial sector’s ability to serve the real economy is undermined when competition breaks down into a more adversarial relationship. 

By aggregating those with surplus funds with those in need of funds to allocate scarce capital to projects which society values, the financial sector bridges trust gaps between individuals and companies using its own trust reserves.  Its profit derives from this work pricing known risks and absorbing uncertainties in a way that creates value for society and the economy.   When the financial sector loses society’s trust and the support of institutions which reflect the interests of society (government, regulators and civil society), financial institutions become less able and willing to be exposed to uncertainty and may become more risk-averse. 

 

Building Trust

Trust is not itself a measurable quantity except in its absence.  The RFI Foundation, for instance, is working with partners to develop a tool to increase the effectiveness of existing sustainable and inclusive finance initiatives which together are working to rebuild the trust between society and the financial sector.  The initiative builds upon the need to provide validation of commitments and actions that are linked to sustainable and inclusive finance.  By providing this validation to commitments made within the context of other sustainable and inclusive finance initiatives, we believe the trust-building process can be accelerated and strengthened. 

Regulators, central bankers and others involved in protecting the stability of the financial sector understand that the lack of trust in financial services institutions has real-world consequences.  The New York Fed’s William Dudley suggests that measurement and accountability on the rebuilding of trust and creation of a healthier culture within the financial industry “ are paramount to us as supervisors and central bankers”. 

Dudley and many others across the financial industry, in central banks and in civil society organizations recognize that the lack of trust in the financial industry:

  • inhibits the ability of financial institutions to effectively act as risk-bearing intermediaries connecting providers of finance with those who need it;
  • limits the creation of public and financial industry benefit from sustainable and inclusive finance; and,
  • undermines central banks’ and governments’ future ability to support the financial system in future crises.

RFI aims to address some of these needs through its Collaboration and Decentralization to Promote New Incentives to Rebuild Trust (CDIT) Initiative. It is hoped initiatives such as this would build more trust in the industry in the years to come.

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