Business Ethics and Corporate Governance: Bank of Africa - Case Study Example

Case Study

Businesses are influenced by decisions and conducts of the executives. The corporate governance defines the business culture, their risk-taking behaviour and compliance with the organisational policies. The executives have the responsibility to safeguard the interests of the stakeholders. However, in most cases managers pursue personal interests at the expense of the stakeholders and especially the shareholders as a result of the separation of business ownership and control. Therefore, corporate governance is crucial because it sets standards within which the executives are expected to operate and provide the stakeholders with a yardstick for measuring the performance of the managers (Dover,  Hariharan & Cummings, 2014: 445). Ethics and principles of corporate governance determine the success or failure of the organizations. This study explores the case study of the collapsing of South Africa’s first bank with an aim of providing an analysis of the conducts of the executives regarding ethics and corporate principles, their competence in financial matters and how their integrated corporate governance with ethics in lending behaviour. Also, the study compares the African Bank with Lehman Brothers by examining the conducts of the CEOs of the two organisations and establishes the weakness of the system of corporate governance both in private and public sector.

The directors of a corporation have a fiduciary duty to safeguard the interests of the stakeholders and can be held liable for any loss, cost, damages or any breach of fiduciary duties to the organisations as stipulated in the Companies Act of South Africa. The probe into the collapse of South Africa Bank disclosed that some of the managers lacked relevant qualifications or acted unethically in discharging their obligations. Although the conducts of the directors did not reveal any motive to defraud the company, their reckless behaviour might have cost the investors a big fortune (Donnelly, 2016). For instance, the managers resulted in aggressive lending with an aim of increasing the company’s revenue which led to massive loss of credit. The company offered prolonged unsecured loans to the customers whose situations were deteriorating with the hope that they would recover with time and start repaying the loans which never happened.

Unlike in the other institutions where the duty of the directors is mainly to safeguard the wealth of the shareholders, the directors of a financial institution have an additional responsibility to take care of the creditors’ resources as stipulated in Basel Principles for boosting corporate governance. The bank board must possess particular characteristics (Donnelly, 2016). They should have adequate experience in banking to enable them to evaluate the conducts of the management, implement internal controls and ensure compliance with audit and bank regulation for effective formulation of strategies and management of risk. Ethical behaviour is determined by the acceptable conducts in the society or the beliefs of what is right or wrong. The decision by the Ellerine to provide unsecured loans to the furniture retail business has been termed reckless and unethical. For instance, the probe established the chief risk officer was a habitual drunkard and unqualified for the job thus his capacity in the business may have exposed the organisation to severe lending risks.

Question 1: Compare the African Bank debacle to the similar disaster at Lehman Brothers.

The collapse of African Bank had many causes and reasons. In the year 2014, the African Bank was bailed out by South African Reserve Bank (SARB) at a cost of 1.6 billion US dollar. The bank had announced of its anticipated 600 million dollars in loss and then followed by the resignation of the CEO Leon Kirkinis leading to plummeting of the price of African Bank’s stocks by about 80 per cent. Leon Kirkinis was crucial in the establishment and existence of African Bank (Donnelly, 2016). He had founded Theta Investment Group in 1993 to offer funds through a capital market in a bid to serve the market that had been left out by the conventional banks. In 1998, Theta Investment Group purchased the African Bank to extend the lending facilities. In 2008, Leon discovered a growing borrowing opportunity in the furniture industry and to strengthen the power of lending he purchased Ellerine Holdings Limited at a cost of about $860 million. However, contrary to Leon’s expectation the furniture lending business was not profitable and was taking extremely long to recover the cost (Dhillon, 2014). The African Bank had exposed itself to great insecurity due to unsecured lending to tap the opportunities available in the furniture market.

Richard Fuld, the CEO of Lehman Brothers, was on the steering wheel during its collapse and was instrumental for its survival in the previous financial crisis the Asia financial crisis of 1997. Similarly in September of 2008, the Lehman Brothers filed for bankruptcy according to Chapter 11 of the Bankruptcy Act because something had gone wrong with their investments (Dhillon, 2014). This followed the huge investment Lehman Brothers had made in the highly booming housing industry in 2003 and 2004. To synergise its lending facilities Lehman Brothers acquired five mortgage lenders such as Subprime lender, Aurora Loan Services, and BNC mortgage. Some of these lenders such as Aurora were targeting highly risky market Alt-A loans which had the low credit rating for the traditional bank loans. The stock price of Lehman Brothers had grown tremendously to a peak of US$86.18 in 2007 before the problems started with Subprime mortgages that led to significant decline in its stock prices.

It is arguable that unreasonable decisions by Fuld were the main reason for the collapse of Lehman Brothers. He acted arrogantly. He overestimated the value of its assets and scared away the potential Korean buyers. Furthermore, his optimism and charismatic leadership style led him into providing unsecured lending believing it was the only way of helping the poor borrowers to get them out of poverty (Hudon, 2007). Though his view was not backed by any research findings, Fuld was optimistic that unprotected lending was crucial for the economic growth, and he claimed that the poor people had the capacity to repay their loans. Leon Kirkinis echoed Fuld’s sentiments claiming that unsecured lending was relevant in the South African economy because it helped the poor to educate their children, build houses and meet other day-to-day obligations thus improving their lives and the entire economy (Donnelly, 2016). By working on what he believed in Kirkinis created authentic value for the economy, debtors, and investors.

QUESTION 2: Discuss the ethics of ‘lending to the poor.'

Ethics is crucial in any business because it sets the boundaries within which the plays are expected to operate. Businesses are established with the main motive of creating wealth for the shareholders through profit maximization (Bourn, 2008). Lending of loans involves charging certain interests rates on the amount lent to earn interest. Most poor people do not qualify for loans in the banks because they lack collateral to secure their loans. The lenders need a very high level of certainty that the amount lent will be repaid with interests when the time is due. To gain the certainty, they require the borrowers to back their loans with valuable assets as collateral for securing the loan. Sometimes poor people are regarded as lazy, irresponsible and reckless hence, they rarely succeed in business (Dhillon, 2014). Furthermore, because of their nature of businesses the poor people have unstable income and usually earn small profits from their business. Lending to the poor focus on stabilising their income through the building of assets and security creation.

Now the issue is not whether financial institutions should lead to the poor clients, but how they relate with the poor borrowers. Businesses have a duty to satisfy their customers by ensuring fair dealings and quality of services. Irrespective of the nature of the organisation the business has a responsibility not to harm the poor.

Some lenders engage in predatory lending behaviour which involves fraudulence, deception, and unfair practices. The predatory lenders impose abusive and unfair terms to the borrowers that put them in worse financial status than normal. The lenders may fail to disclose the entire cost of lending or other terms in order to convince the borrower that the loan is cheaper than the actual cost. The loans advanced to the poor borrowers usually carry high-interest rates because to cover the high operation and transaction fees since a number of borrowings are generally small. The microfinance institutions are charging anywhere between 20% and 60% per annum (Hudon, 2007: 1). In Mexico, the average interest rate for microfinance is 30% although some institutions such as Banco Compartamos charge as high as 100% to the poor borrowers (Dhillon, 2014: par. 14).

Some researchers have argued that the poor borrowers have the capacity to service high interest’s charges due to the high rate of turnover of their borrowings than the borrowers of huge amount. However, lenders should be ethical when dealing with poor and avoid taking advantage of their circumstances to charge them unreasonably high interests. Some religious institutions including the Muslim-based financial institutions and those operated by Jews are opposed to charging the borrowers interests and come require the lenders to impose small charges to cover the transaction cost. They impose laws to control the conducts of the lenders and protect the borrowers against unscrupulous lenders (Hudon, 2007: 3). Basing the argument on the deontological ethics, lenders have an obligation to do right the borrowers by not overexploiting the poor borrowers (MacKinnon & Fiala, 2014: 114). The lenders should be just and disclose all the information to the borrowers besides charging reasonable interests.

QUESTION 3: Was African Bank's business model ethical?

When offering loans to poor people morality and sustainability concepts should be of central concern among the lenders. The collapse of the African bank can be used as a classic example of how unethical issues can cost the investors, borrowers and the economy dearly. There was nothing wrong with African Bank providing loans to the poor borrowers without collateral for security because many micro financial institutions do the same and have improved the lives of the poor people significantly. However, the questions many people have raised regarding the African Bank lending model were whether the management practiced ethics at all.

It is morally acceptable for the business to make huge profits from their business activities so long as they act ethically. However, the African Bank charged exploitive interests rates on their poor borrowers without justification or regard for sustainability (Donnelly, 2016). The bank sold highly priced furniture to desperately poor people on credit through Ellerines. However, the uncontrolled lending had devastating effects on the bank because of the high default rate. Also, they offered other home appliances such as TV sets and couches at an exaggerated prices and unclear terms and conditions that plunged the borrowers into financial crisis. The bank advanced loans for furniture business although they were aware the business was not profitable enough to service the loans. Therefore, it was apparent that the model lacked transparency which is crucial to ethical practices in lending.

The lending model should be clear and manageable as a pre-requisite for ethical practices by the lenders. The African Bank used their furniture business to advance loans to the poor customers. Although there was nothing wrong lending of assets to the poor customers, it was unfortunate the bank used the opportunity to defraud the unsuspecting customers. Banking and retail business could not pursue the common goals the model lost the aspect of lucidity thus making it complicated to manage.

Another crucial aspect of ethical loan model is the consideration of value for the customers. The issue of value could imply the benefits customers would gain from financial products. Although furniture adds value to the consumers since these are essential items in the household, it can be argued that the bank would design better financial instruments to provide more value to the customers. For instance, the poor consumers would gain more value from loans to support their businesses because they lack steady income.

Although there was no evidence that the bank had an intention of defrauding the investors, it is crystal clear that the management acted negligently in many ways. For instance, the directors did not conduct periodic evaluation of the managers to ensure they were acting within the acceptable parameters. Furthermore, the seven out of the 11 directors did not have any experience in banking which the question about the seriousness of the bank in protecting investors’ money (Donnelly, 2016). The bank engaged in irresponsible lending because most of the borrowers were below the borrowing threshold. In other words, they engaged in reckless lending since close to 50% of the customers had had arrears and were unqualified for another loan yet the bank extended them more loans.

Furthermore, the managers were earning huge salaries and commissions that may have drained the investors’ capital. Therefore, lack of adequate protection for investors funds, reckless borrowings, exorbitant interests charges, huge salaries and commissions by the managers, huge lending of unsecured loans and unclear terms and conditions demonstrates that the lending model was unethical.

QUESTION 4: Does this catastrophe reveal a basic weakness in our contemporary system of corporate governance?

The corporate governance is concerned with organisational structures and control processes. It focuses on the relationship between the board of directors, management, shareholders and the other stakeholders. It defines the rights and responsibilities of various participants or stakeholders in the company. The collapse of Enron in 2001 and WorldCom (U.S.) in 2002 have sent an awakening message in the corporate world. The international institutions such as International financial reporting standards (IFRS) provide guidelines on effective financial reporting and to a greater extent, they promote good corporate governance. The organisations managers are required to act in a certain way to promote the interest of shareholders and other stakeholders. However, due to agency relationship the management does not always work for the interests of the shareholders, but instead they work to serve personal interests (International Monetary Fund. Monetary and Capital Markets Department, 2015: 27). This conflict of interests results in failure of good corporate governance because the managers may exercise unethical behaviour which puts the interests of other stakeholders at stake. A good example is the case of Enron Company, which engaged in unethical conducts by misrepresenting its financial information in the balance sheet with an intention of reflecting favourable performance (Norlia et al., 2011: 209). It is unfair deals led to bankruptcy and drastic decline in stock prices from over $89 to less than $1. Similarly, the case of African Bank depicts corporate failure in lending of loans to the poor and ensuring effective management of shareholder’s finances. There were inadequate measures to safeguard the stakeholders’ interests by the organisation leading to the conflict of interests and subsequent collapse of the organisation. Apart from the irresponsible lending, there was a lack of accountability or mismanagement of investor funds and involvement in illegal activities.

QUESTION 5: If so this is so where are the weakness located?

The collapse of African Bank was contributed due to corporate failure as managers engaged in lending huge unsecured loans to low-income borrowers who lacked credit score for such loans (International Monetary Fund. Monetary and Capital Markets Department, 2015: 29). Also, the managers were making huge earnings from the business at the expense of investors. The incompetence by the board of directors to oversight the conducts of the managers was also contributing factors to the collapse associated with corporate governance (Norlia et al., 2011: 210). While corporate good governance requires the organisation to take the interest of all stakeholders, the dubious lending to the poor people without clear terms and conditions was an immoral practice depicting a conflict of interest as managers may have wanted to earn huge salaries from the commissions and also portray the company as having good performance.

According to Dover et al. (2014: 446), the audit report established several cases of mismanagement of investor’s money and a R1 billion run on deposits. The top bank officials were accused of insider trading that led to a drastic decline in stock price. Also, the management could not account for about R2.6 billion as of the year 2013.

QUESTION 6: Are these weaknesses as set out in question 5 above, similar those that can be found in the public sector? Discuss.

Unlike the private sector whose main focus is wealth maximisation through the generation of profits public sector aims to provide services besides public goods to the citizens (Bourn, 2008: 37). The private business operates under company Act and other legislations while public sector operates in accordance with the regulations set by the Act of Parliament. The failure of corporate governance in the public sector has more causes than in private sectors. To start with, just like in the private sector the directors of the public sector have self-interests usually political in nature. In most cases the directors are appointed not on the basis of their qualifications and expertise, but to achieve political goals of the ruling government (Edwards et al., 2012). Consequently, most government projects fail to meet the public expectations because the management is held in the labyrinth of conflicting goals.

Also, there is an issue of the inefficiency of because of lack of expertise among the directors of the public corporations. They initiate shoddy projects which are irrelevant or inadequate to satisfy the needs of the beneficiaries. Most of these projects collapse before completion due to lack of support by the senior government officials (Bourn, 2008: 11). There is also an issue of overpricing of projects which result in the embezzlement of public resources. For instance, studies have established significant failures in IT projects in the UK. In IT projects initiated in 1995 only 16% of the total projects were completed on time while 31% collapsed or were cancelled during the implementation, and further, 53% exceeded the initial cost by over 189% (Calder & Moir, 2009, 60).

The main difference between public sector and private is the source of funding. The private sector obtains funds from tax payers while the private sector relies on funds from investors. While it appears both private and public sectors suffer related issues of failure of corporate governance, it is apparent that the issues with public sector comes to limelight through notification on the national newspapers while for the private sector the issue may continue lingering until it renders the organisation underperforming or is declared bankrupt (Bourn, 2008: 39). However, the private sector is under severe scrutiny to protect the investors’ funds than public entities. Additionally, the public sectors are influenced by a bureaucracy that reduces the efficiency of implementation of projects than in private sector. Furthermore, the public sector may offer grants or interest-free loans to the poor to promote their social welfare, thus promoting good corporate governance. This is unlike the private sector that provides loans at exploitative interests’ rates to achieve individual or organisational goals.

In conclusion, good corporate governance is crucial for the effective performance of the organisation. It ensures managers are responsible for their conducts. Business ethics is part of good governance. The collapse of African Bank and Lehman Brothers are a classic example of the failure of good governance. Banking institutions should observe ethics when lending to ensure to avoid putting the interests of stakeholders at stake. Unreasonable business practices can jeopardize the business operations and can cripple the economy. Lenders should ensure they charge reasonable interest rates. The case of Africa Bank depicts similar situations of failure in corporate governance facing the public sector. There is a lack of transparency, the high cost of capital, the inefficiency of the board of directors as well as personal or political interests which overshadow stakeholders’ interests. Furthermore, bureaucracy in the public sector contributes to the high rate of project failure or unnecessary delays. Organisations can achieve greater efficiency by upholding ethics and corporate governance.