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Ethics in Lending

by Regional Examiner Jeff Bagby, Oklahoma State Banking Department

That didn't affect me one bit. What kind of person would I be if a little Caribbean cruise and the use of your company plane could influence my decision on whether to make your loan or not? It's not like you're my brother or anything. THAT would be inappropriate. By the way, thanks for the Super Bowl tickets.

What is your standard for appropriate or not? Good or evil? Right or wrong? That is the ongoing dilemma that thousands of professionals face day after day in their chosen industry. Like it or not, business people are responsible to conduct themselves in an ethical manner just like the physician, pastor or attorney. In financial services, the lender is bestowed with the assumption of expertise in the eyes of the hopeful borrower. The customer comes to the lender and opens up his or her most private financial issues for analysis and critique. At that point, the lender has to make a decision based on their standard of conduct. People base their actions on a variety of standards which lead to questions such as - Is it legal? Can I get away with it? What is company policy? What would Jesus do? Yet the most compelling question may be - Would the situation before me diminish my ability to make objective decisions for the bank?

The abuse of this privileged position is subject to ethics rules and some law. But not a lot of law. It is a very gray area. Often nobody except for the IRS cries foul unless the under the table dealings bleed over into the public sector. For banking it is getting more stringent, however. The fact that the industry is a hybrid (public/private) is a twist that brings into play more governmental control, which is a feature that will never change as long as the government insures deposits. Bankers generally tailor their actions by the Federal Bank Bribery Law which makes everything beyond accepting a few pens and pencils appear to be a felony. Subsequent to its initiation, the powers >
Ethics watch dogs are certainly more prevalent in the public sector. We see it in the political realm all the time. Especially when the media thinks they have a scoop on an elected official abusing the public trust (read: spending taxpayers' money on themselves). Then the 500 watt halogens will be turned on that issue and paraded across the world or local stage for all to see and pass judgment. It usually ends badly for the penitent offender. Even in my line of work - supervising banks and enforcing banking law on defenseless bankers - accepting gifts or gratuities is tenuous. The unofficial ethics motto is "don't do anything that you wouldn't want plastered across the front page of the local newspaper".

State legislators are making efforts to reduce gifts and gratuities to minimal amounts today with a long range desire to outlaw gratuities of any sort in the future. Now, if we can just get legislators in the federal government to outlaw lobbying? To their credit, certain federal regulatory agencies have a standing prohibition against the acceptance of any gratuity for any reason.

Much of the time, the negative consequences of unethical conduct in the business world is not as clear cut as in the realm of medicine, religion or the public sector. Cutting corners in the quest for the almighty dollar might carry less moral weight since money is evil anyway. So what's the big deal? The bigger deal is the butterfly effect. One action done with "good intentions," weakens the system built on trust and then it compounds like interest on a certificate of deposit. The more immediate impact has to do with your bank. How a bank makes ethics decisions can generate the same result as the CEO standing in the main intersection of town yelling to the community that the bank will treat certain customers a certain way. But it comes in the form of polite conversation down at the local diner. If the decisions are ethically bad then get ready. Over time, less than objective decisions flower into problem loans, loan losses, lawsuits, weakened earnings and capital and fired loan officers.

You have to go back to the basic premise, though. A lender is an agent of the financial institution - which survives on its image of dependability - and that person has to accept his/her service oriented role as a solemn trust bestowed on them to act in a way which is best for their client or customer. Without that level of trust which is earned every day, the industry is diminished. That is the very reason that the FDIC was formed. Not to hand out $100,000 to everyone that had money in the bank. It was to establish or restore faith in the banking industry so that business could continue and the economy could flourish.

There was a case in our state that chronicled one bank's misuse of its position of trust. A customer walked into the bank and told the loan officer that he had a real estate property that he wanted to buy. The price was well below the market for a variety of reasons so there was equity built in to the deal. The customer wanted to borrow the down payment since the owner was going to carry the note. When the loan officer realized what a great deal it was, he ran it by the loan committee and then told the customer the bank did not permit 100% financing. That's reasonable except that within a week, the wives of the president and senior vice president of the bank raced out and bought the real estate in question ahead of the customer.

The devastated customer brought suit against the bank and in the original court proceeding, the bank maintained that it had no confidential duty to its customers and if there was any blame, it was the loan officer's as an individual. Incredibly, the trial judge agreed, but the appeals court judges gathered in the unrestrained jurisprudence and reversed the decision declaring that the bank breached its duty of confidentiality and the loan officer was its agent. To be fair, it happened in a time before the current privacy laws were in effect, yet it set a positive precedent (after the appeal).

Compliance with existing laws need not be difficult. The Board can have success following a simple three pronged format. Establish policies, audit compliance with those policies and enforce the policies. If your bank does not have an ethics policy or code of conduct, refer to the Federal Bank Bribery Law. Many banks copy that closely. Be specific on what is allowable and state within the policy what will happen if the guidelines are not followed. Management must regularly audit compliance with their policy. Without regular review, anything can happen. It wasn't until the Department of Homeland Security audited their employees' use of agency credit cards over a six month span that it was determined 45% of all purchases in the name of the agency were deemed inappropriate. The audit disclosed items such as unaccounted for laptop computers, a beer brewing kit for a Coast Guard official, three portable shower units at a collective cost of $71M - nearly three times the typical price, and $7,000 in iPods for Secret Service training.

The audit function sets up the third facet. Enforce the policies. This can be the most challenging for management. Yet without it, the other functions become irrelevant. And it highlights the fact that ethical behavior starts and ends with management. Without proper leadership both in modeling desirable behavior and enforcing the policies that require appropriate conduct, management might as well sell out to the highest bidder. By the way, somebody named Abramoff is on line one?.

Jeff Bagby is a Regional Examiner with the Oklahoma State Banking Department. He has spent 17 years in bank regulation which includes a wide spectrum of knowledge and experience. In the early part of his career, the banking industry in the central region of the United States endured its most devastating era since the FDIC was established bringing with it numerous bank closures. In addition to writing examination reports and working with bank management, Jeff teaches Loan Officer Seminars aimed at revealing to bank lenders how and what an examiner looks for when reviewing loans.

Jeff received a B.B.A. from the University of Oklahoma in 1985 and is a graduate of the Conn Graduate School of Community Banking.

First published on 10/11/06

First published on 10/11/2006

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