Study Calls for Best Practice Codes of Conduct to Control Conflicts of Interest in Financial Services

Authors: Andrew Crockett (Former General Manager, Bank for International Settlements), Trevor Harris (Co-Director, Center for Excellence in Accounting and Security Analysis, Columbia Business School), Frederic Mishkin (Columbia Business School), Eugene White (Rutgers University)

In the continuing corporate scandals, conflicts of interest have plagued the financial industry. The ubiquity of these problems has raised critical questions about the ability of both the market and government regulation to assure investors that they can place confidence in the information provided to them by financial institutions and thereby make wise investment decisions. Written by four distinguished financial economists, 'Conflicts of Interest in the Financial Services Industry: What Should We Do About Them?' is published by the International Center for Monetary and Banking Studies and the Centre for Economic Policy Research. This Report offers a new and general framework for understanding conflicts of interest across the financial industry and a systematic approach to determining appropriate policy remedies.

The Report provides an in-depth examination of the conflicts between underwriting and research in investment banking; auditing and consulting in accounting firms; credit assessment and consulting in rating agencies; and commercial and investment operations in universal banking. The combination of services within a single financial institution yields synergies that lower costs and improve the quality of services. However, by serving multiple interests, conflicts arise that may be exploited at the expense of some of the firm's customers. The study shows that while many conflicts of interest exist, they are usually difficult to exploit. The market is often able to create incentives that constrain conflicted institutions. But, when the market cannot provide adequate discipline, policy remedies must be carefully selected as they may reduce the synergies as well as the conflicts, imposing a high cost on the financial industry.

The authors of the Report make a total of nine recommendations to remedy the conflicts of interest in the financial services industry:

It is important to recognize that markets do not immediately create optimal structures to solve conflicts of interest problems. As the history of universal banking suggests, financial markets move to manage conflicts effectively over time. Overall, these nine recommendations rely on the combination of market discipline, supplemented by mandatory disclosure of conflicts and supervisory oversight to keep conflicts of interest from damaging information production in the financial system.

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