Banks and trust: No honor system here

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Published: Saturday, 13 Jul 2013 | 11:48 AM ET
By: | Managing Editor, CNBC.com

There was a really important development this week about a key interest rate that influences all sorts of loans and financial securities around the world. The event pointed up 3 things …

—Honor systems don't work, at least with banks

—The solution to replace the honor system in this case may not work either

—The general public tends to ignore complicated things, so there's little shame

The honor system at issue here was basically a survey among banks used to calculate a benchmark interest rate. They lied and were caught.

Funny. People from all walks of life will dutifully shell out the right amount of money at a self-serve fruit stand or hardware store. Why can't that work in banking?

"The reason has to do with context and culture," answered Robert F. Hurley, a psychology professor at Fordham University and author of the book "The Decision to Trust". "You see the fruit stand is a low-risk environment where there is a neighborhood or community feel. What about the world of banking?"

With the exception of community banks, the context of banking is "not set up for trust," the professor explained.

"Many large universal banks have garnered reputations for serving their interests, sometimes at the expense of communities and even clients," Hurley continued. "This has induced distrust which has shown up in dramatically lower trust scores for large banks."

He added that research in psychology confirms that people are primed to trust or be suspicious by the context and culture that they're operating in. "Unfortunately, the universal banks have created a context and culture that is closer to the used car lot than it is to the fruit stand," Hurley said.

Okay, so the honor system is out. And this week, control of the benchmark interest rate at issue was sold to an American stock exchange for one British pound.

Will that be any better? Maybe. Exchanges have practice reining in greedy profiteers. After all, the casino owner has a vested interest in maintaining the perception that the casino is fair.

But some have their doubts. Exchanges, after all, are looking to make a buck as well.

"We had a 'fox guarding the hen house' issue here, and we should learn from that," Bart Chilton, a commissioner on the United States Commodity Futures Trading Commission, told CNBC. "I firmly believe that having a truly neutral third party administrator would be the best alternative, and I'm not sure that an exchange is the proper choice." (Regulators have their own ideas...see the video)

What Are the Alternatives to Libor?
Gary Gensler, chairman of the U.S. Commodity Futures Trading Commission, talks about the Libor rate and the possible alternatives.

Of course, this whole scandal kind of flew by the general public's eye. This benchmark rate is complicated and full of jargon, and that tends to scare off readers. Our stories on the subject weren't widely read (I've whined about this before). But if some folks looked at the fine print on their mortgages (especially jumbos) or commercial business loans, there's a good shot they'd find this rate referenced.

But when the public doesn't pay attention, there is no shame about breaking the rules. That gets us back to the honor system. Perhaps that's a failing of society to understand what's important or a failing of the business media to explain the situation better. (Here's our shot at explaining...ok I'll finally say it... the London Interbank Offered Rate or Libor).

Either way, someone got caught ripping off the fruit stand. Now they don't get to use it anymore.

Note: Hey Wall Streeters...Dr. Hurley's Consortium for Trustworthy Organizations is holding a session on "Trustworthiness and Banks" this Wednesday. Just sayin'....

— Allen Wastler is managing editor of CNBC Digital. Follow him on Twitter at @AWastler

The resolution of a recent rate-setting scandal points up that banks lack the context and culture to work on an honor system. But there are doubts about alternatives.
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