Financial Services: A Sector Analysis

4 May, 2023

financial industry

By Luke Patterson and Tess Buckley

The Introduction

The financial services sector makes up the backbone of the economy, and thus holds an important role in our functioning as a society. It is embedded in much that we do and enables many of the things that we value. It forms a large, and often underappreciated part, of what makes the world as we know it operate. This kind of power provides financial services with the unique opportunity to advance a fair, equitable and flourishing society by encoding principles of digital responsibility into the ways that they operate. However, it also presents the risk of worsening pre-existing inequalities by augmenting the divide between the privileged and wealthy and the underprivileged and poor.

This article will present current trends in the financial services sector and highlight the companies with the highest, lowest, and most improved digital ethics standings according to an EthicsGrade scoring. An ideal outcome is that the reader comes to understand and act on the business imperative of corporate digital responsibility (CDR), and is better placed to hold financial service firms accountable for their actions within the landscape of digitalisation.

The Analysis

As in every industry, the rise of emerging technologies has brought significant changes to the financial services sector, with companies leveraging artificial intelligence (AI) and automation to drive efficiency. As financial service firms attempt to navigate the risks posed by these emerging technologies it is crucial that they adopt compliance frameworks and robust AI governance to ensure responsible practices.

Landscape Analysis: Financial Services Sector

In this era of digital transformation, AI has become an integral part of our daily lives, revolutionizing business operations. For financial services professionals, harnessing the power of technology is crucial for enhancing business efficiency. It is imperative to emphasize the importance of CDR particularly in light of impending AI and cyber regulations. By leveraging technology solutions ethically, financial institutions can ensure sustained profitability while aligning with the financial services sector AI gold standards and regulatory requirements. This won’t only benefit firms, but ensure that the practices of financial services firms are working to democratize access to finance rather than limit accessibility to the already wealthy.

AI ethics holds not only a moral imperative but a business case for financial professionals. As the primary motivation within the financial services sector is to make a profit, it is essential to understand the monetary value of digital ethics. Rather than viewing the risk and rewards of AI as a delicate balance, it is crucial to adopt a mindset that recognizes the immense benefits of prioritizing the avoidance of technological harm. Deploying AI systems without proactive efforts (such as ethics by design where you plan for contingencies in a defensive pre-production approach) can and will lead to tech scandals and fines, erode consumer trust, and expose businesses to further risk.

The key lies in understanding that potential benefits and ethical considerations are not in opposition or mutually exclusive, but rather integral components of a unified ESG strategy. To harness the potential benefits of AI, businesses must incorporate ethical considerations for sustainable success, which not only safeguards users from risks but also provides a long-term competitive advantage. Embracing CDR simultaneously increases value while mitigating risks; the ideal combination for financial service professionals. By adhering to ethical practices in AI use, financial institutions can strengthen their reputation, build trust with customers, and position themselves at the forefront of their industry.

Sector Trends

The average EthicsGrade for financial services companies in 2023 was a ‘C’, highlighting that the majority of companies are yet to integrate full environmental sustainability, social justice and corporate governance (ESG) strategies across the whole of their operations, especially in the context of their digitalisation strategy.

Most companies’ digital responsibility practices improved, from an average of 51.46 in Q4 of 2022 to an average of 55.17 in Q1 2023.

financial services ESG performance

The top-ranked financial companies in Q1 2023 are:

Santander Group 75.19 (EthicsGrade B) Munich Re 67.19 (EthicsGrade C) Swiss Re 66.62 (EthicsGrade C) Prosus Group 66.41 (EthicsGrade C) NatWest Group 65.29 (EthicsGrade C) Citigroup 64.70 (EthicsGrade C) Lloyds Banking Group 64.27 (EthicsGrade C) JP Morgan Chase 63.62 (EthicsGrade C) Credit Suisse 63.56 (EthicsGrade C) Allied Irish Banks 63.08 (EthicsGrade C)

The Highest Score: Santander Group 75.19 (EthicsGrade B)

In the first quarter of 2023, Santander emerged as the leading company for CDR out of the 48 companies graded. Notably, Santander's Q1 score exhibited a significant improvement compared to previous quarters, reflecting their heightened emphasis on CDR. Santander’s performance stood out in two crucial dimensions of the EthicsGrade model: ethical risk and structure.

Our research revealed that Santander has demonstrated a commitment to engaging with the social impact of technology, which set them apart from the other graded financial services. While transparency remains a challenge for the industry at large, Santander has taken strides toward the responsible implementation of technology in their internal structure and day-to-day operations.

A notable improvement is Santander’s focus on enhancing customer digital engagement through AI-driven personalized insights within their operating markets. Furthermore, Santander, in collaboration with the University of Chicago, launched an international upskilling and reskilling program aimed at improving AI literacy. Through these initiatives, they have shown dedication to implementing AI technologies while prioritizing the explicability of algorithmic decision-making. Santander does not only speak of commitments to CDR but has demonstrated actioned practices which evidence this commitment, as shown by a Banco de España study in 2022 focused on explicable machine learning models.

Santander's annual report underscores its CDR commitment not only to existing ESG strategies but also to forthcoming AI regulations within the EU. This proactive engagement with AI regulation positions them as a significant contributor in shaping the future regulatory landscape surrounding digital technologies, setting expectations for their peers and leading the CDR standard.

Alongside considerations for the AI Act, it is evident that Santander is well-prepared for the implementation of the Digital Operational Resilience Act in 2025. Their latest annual report provides insights into mandatory and continuously updated cybersecurity training processes for employees, showcasing their readiness to strengthen cybersecurity measures and mitigate digital risks. Santander's introduction of a free digital skills course demonstrates their commitment to addressing the career impact of technology, once again highlighting their dedication to AI literacy training.

Santander's proactive approach to CDR, AI implementation, and internal structures for compliance with future AI regulations makes them the highest scorer in the financial services sector for EthicsGrade scoring, positioning them for continued success in the evolving digital landscape. Santander scoring a B is a result of their clearly demonstrated desire to engage with, and take initial steps to act upon, how to responsibly integrate AI and digital technologies into their business processes. Whilst many other financial service firms take it as sufficient to mention their interest in AI in a paragraph of their annual report, Santander contributes to AI ethics discourse by publicly commenting on the principles required to design an ethical artificial intelligence in the financial services sector, and through publicly engaging with AI regulations that are yet to come into effect. This indicates a proactive approach from Santander to responsible digitalisation, where we’re so used to firms only taking steps towards corporate digital responsibility after the material enforcement of regulation through fines. Moreover, they also demonstrate AI ethics as a core component of the way that they are evolving their governance frameworks: how they are turning words into action. For example, they have a technology and innovation committee designed to oversee technology governance, and have committed to the principle of explainability when designing their AI systems.

Santander is an example of a company doing very well in finding its feet within the landscape of digitalisation. One thing that would push them to the higher ‘A’ EthicsGrade is improved transparency on the technical side of their algorithms – the technical barriers to trust. This means leveraging a good governance structure and ethical principles to start reporting clearly on the nature of the way that their algorithms work: the ways they are avoiding unintentional and discriminatory bias, and reporting on how they trace the decision-making process of their algorithms. Given their high engagement with AI ethics issues, we would also expect Santander establish a dedicated AI ethics team soon, which would also lead to an improved score

The Most Improved Score: BNP Paribas 57.62 (EthicsGrade D)

In the first quarter of 2023, BNP Paribas demonstrated the most notable improvement among the 48 graded financial services companies. This advancement can be attributed to their improved performance in two critical dimensions of the EthicsGrade model: ethical risk and structure. We noted that BNP Paribas has taken steps to strengthen its public disclosure of AI ethics practices, particularly addressing algorithmic bias in its annual report.

BNP Paribas stands out for its increasingly transparent approach to implementing AI technologies in its operational processes. They have successfully and publicly integrated chatbots into customer interactions, leveraging algorithmic decision-making to enhance the quality of investment advice and service delivery. However, there is much more to be done amongst all financial service firms with regard to transparency, and BNP Paribas are no exception to this. BNP Paribas would set themselves apart from any of their competitors by offering more in-depth reporting on the nature of the algorithms which they are leveraging to improve their operations. By, for example, publishing the code used to aid financial decision-making.

Despite the advancements in BNP Paribas' overall performance, it still falls below the average score of its industry peers. This gap can be specifically attributed to an insufficient level of detailed information regarding BNP Paribas' cybersecurity strategy – an area where many of BNP Paribas’ peers perform well. In an era of increasing digitization and evolving regulatory frameworks, cybersecurity is a priority for financial services as the sensitivity of the data they handle is especially liable to significant risk of a data breach. Regulators, particularly in the EU, have established legal frameworks to standardize cybersecurity best practices. Preparing for the impending implementation of AI regulations, such as the Digital Operational Resilience Act (DORA) and similar international mandates , is crucial for financial service firms to gain a competitive advantage in the digital finance landscape.

The Worst Score: Farmers Insurance 1.24 (EthicsGrade NR)/Berkshire Hathaway 17.71 (EthicsGrade NR)

Of the 48 companies graded in the first quarter of 2023, Farmers Insurance and Berkshire Hathaway showed the lowest scores, signaling significant areas of concern in their CDR and digital ethics. Both companies received an NR (Not Rated) EthicsGrade, indicating insufficient evidence and public data available for a comprehensive assessment.

Farmers Insurance and Berkshire Hathaway consistently ranked at the bottom of the group in both 2022 and 2023, with no signs of improvement in the quarterly reports during this period. Berkshire Hathaway's score remained at a mere 17.70 (NR) in both years, offering limited information beyond their annual reports, which primarily focus on internal structures and financial performance. They failed to account for sustainability initiatives and digital responsibility considerations in the annual report. Similarly, Farmers Insurance lacked transparency, with researchers unable to access their website successfully in both years, resulting in a score of only 1.24 (NR).

Transparency is critical to EthicsGrade's research, as it affects the results across all dimensions. The availability of public information determines a company's score, emphasizing the necessity for companies to communicate their ESG and CDR strategies and disclose their progress and improvements publicly.

Berkshire Hathaway's public communications are significantly behind their peers who received higher scores. For instance, they provide no details regarding privacy commitments, which has become standard practice in every sector, including financial services. Furthermore, EthicsGrade found no information on Berkshire Hathaway's incorporation of AI technologies into their business processes or their measures to mitigate digital risks. Either they are not keeping up with technological advancements, and risk falling behind in relevance (or overspending to catch up) or they are doing so, but doing so unaware of the risks, and unaware of the need to be transparent in their mitigation of these risks. Berkshire Hathaway's lack of CDR reflects a broader reluctance to adopt ESG principles. Ignoring the necessity of CDR principles will only further isolate the company within an outdated model that fails to consider financial service standards.

The responsible implementation of digital technologies is increasingly under scrutiny, with AI innovation entering the mainstream. EthicsGrade predicts that this scrutiny will soon reach levels comparable to the current oversight of companies' environmental sustainability practices. It is imperative for Berkshire Hathaway and its leadership to allocate significant resources toward improving their broader ESG strategy and digital strategy more specifically. Failing to do so may leave them too far behind leaders in the financial services sector for CDR, such as Santander, making it financially and logistically challenging to catch up as they distance themselves from their competitive peers.

In summary, the current state of Berkshire Hathaway's ESG practices and transparency in digital responsibility raises serious concerns. Urgent action is required for the company to adapt and align with industry expectations before it becomes insurmountable to bridge the growing gap between them and ESG leaders in the financial services sector.

Future Predictions

The increasing emphasis on AI governance brings digital ethics to the forefront of ESG concerns, becoming a topic of discussion in executive meetings and board agendas within the financial services sector. The mainstream adoption of AI, coupled with notable scandals like Getty Images suing, chatbot-related suicides, racist policing technologies such as COMPAS, sexist recruiting algorithms like HireVue, and political polarization through echo chambers and misinformation, has underscored the need to prioritize the assessment of CDR.

As regulatory frameworks such as the AI Act come to fruition, the demand for auditing and consultancy services related to digital transparency will surge. It is essential to approach this landscape with caution, as some entities may capitalize on the hype by offering grading and consulting services simultaneously. Careful consideration and due diligence are required to avoid falling victim to false claims or conflicting interests when selecting appropriate partners in this space. The financial industry’s pre-existing auditing function and strong cybersecurity priorities will prove helpful in not having to reinvent the wheel for AI audits.

AI policy and then a swarm of ESG scandals and fines will be a theme in the coming year. As an industry focused on profit, AI regulations where the noncompliance results in fines will impact financial practices. Regulations are often drafted when a business process causes harm to or exploits people. In this sense, AI regulation is often reactive; this means something goes wrong and then regulation appears.

The Digital Operational Resilience Act (DORA) addresses the challenges present in EU financial regulation, particularly regarding ICT risk management, incident reporting, resilience testing, and third-party risk management. Moreover, adopting a broader business view of resilience, with clear accountability at the senior management level, is crucial for organizations aiming to thrive in this evolving digital regulatory landscape. By embracing DORA's requirements, financial services can enhance their operational resilience and adapt to the changing expectations of the regulatory environment.

DORA highlights the shift towards a broader business perspective on digital resilience, with clear accountability established at the senior management level. It aims to address significant challenges in EU financial regulation which will have far-reaching consequences for financial institutions.

The underperformance exhibited by companies such as Berkshire Hathaway could serve as a notable indicator of potential challenges that lie ahead within an intensifying and unforgiving regulatory environment.

In the financial services sector, it is crucial to recognize the influence of Generation X's moral imperative to safeguard the environment for future generations. As this demographic group grows older, their consumer decisions are increasingly guided by their values, particularly in relation to ESG priorities. This shift in consumer behavior indicates a broader trend among younger generations to seek out services that align with their values. In order to cater to these customers, financial services will have to showcase considerations of ESG strategies. Financial companies that demonstrate strong ESG considerations stand to gain a significant competitive advantage. By integrating ESG factors into their business practices, these companies can attract and retain customers who prioritize sustainability and ethical responsibility (Gen X). Embracing CDR principles not only aligns with the moral imperative of safeguarding the planet but also positions financial services providers as trusted partners for individuals and businesses seeking value-aligned solutions.