BUSINESS FINANCE

Course Code: BUSFIN

Prepared by:

JUNE CLYDE D.
FAMOSO

Reviewed by:

LIZEL S. SOSMEÑA
SHS- OIC PRINCIPAL

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 MODULAR INSTRUCTIONS FOR BUSINESS FINANCE

COURSE CODE: BUSFIN

COURSE TITLE: BUSINESS FINANCE
COURSE DESCRIPTION:
Business Finance engages the larners to appreciate the fundamental principles, tools,
and techniques of the financial operations involved in the management of a business
enterprise. This module is enriched with comprehensive learner-centric activities that
aim to develop the learner's competence in the analysis, evaluation, application,
preparation, and development of financial plans and programs that are suited in a
business or organization.

COURSE OUTLINE
1st Quarter
Week 1 & 2: Introduction to Financial Management
Week 3:
Week 4:
Week 5:
Week 6:
Week 7:
Week 8:
(for SHS 8 Weeks)

ASSESSMENT:
• 70% Performance Task : Quiz, Assignments, Outputs
• 30% Term Assessment (for SHS 30% Quarterly Assessment)

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Week 1: Introduction to Financial Management
Specific Objectives: (LO of OBE)
At the end of the chapter, the learners are able to:
• Define Finance.
• Describe who are responsible for financial management within an
organization.
• Describe the primary activities of the financial manager.
• Describe how the financial manager helps in achieving the goal of the
organization.
• Describe the role of financial institutions and markets.
______________________________________________________________________
Discussion Proper:

Opening Case

Pablo Perez is a senior high school student. While studying, he works as a part-
time merchandiser in one of the supermarkets near his home. He is earning 2,000 per
week. He plans to save up a portion of his earnings to help his parents pay his college
tuition fees. After six months, he was able to save 30,000. He is contemplating on how
he can still make his savings grow. One afternoon, after he closed his social media
account, he researched on ways on how he can still make his money earn. He was able
to research three ways: to deposit his money in a bank; to make his money available
for borrowing; and to infuse his money as an additional capital in their water-refilling
station business.
If you were Pablo, what would you do with the 30,000 savings for it to grow?
What would you consider in making such decision?

Introduction

All people need money to live. While it is true that the love of money is the root of all
evil, the prudent and wise of money can result in many good things – a better life and
more secured future. In fact, if you are going to ask yourself why you are in senior high
school now studying and reading this module, you will get a resounding response
saying “because you want to have a better life.” The diploma that you will be getting
upon graduation will serve as your ticket to land a job, to enter college, or to put up
your own business.

Fast forward, you will find yourself earning your own money, being financially
independent, and making financial decisions. In making these decisions, it is important
that you consider the financial environment where a financial system operates.

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In the opening case, Pablo can better make wiser decisions on how he can grow his
money if he is familiar with the financial environment where individuals, institutions,
governments, and business acquire, spend, and manage their financial resources.

What is Finance?

In simple terms, finance is the study of how the players in a financial system acquire,
spend, manage, and make other sound financial decisions concerning money and other
financial resources. Money is anything generally accepted as a means of paying for
goods and services and for paying off debts or liabilities. Money performs three basic
functions: 1.) as a medium of exchange; 2.) as a store of value; and 3.) as a standard
of value.

Generally, sound financial decisions contribute positively to individuals, businesses, and

the economy. As such, these should be made thoughtfully. In making sound financial
decisions, three important concepts, all else remaining equal, must be remembered:
• More value is preferred than less;
• The sooner the cash is received, the more valuable it is; and
• Less-risky assets are more valuable than or preferred over riskier assets.
If you are thinking that only working individuals, entrepreneurs, and businesses make
financial decisions, then you will be benefiting more from this subject than the rest.
Perhaps, your first lesson is to know that you do make financial decisions on a daily
basis. Similar to Pablo, you, at some point, had to decide whether to spend all of your
allowance on food or to save some for future use. Similarly, there was a time when you
had to make a decision on which writing pen and notebook to buy for the upcoming
academic year.

Reasons to Study Finance

From the preliminary understanding of finance, it is best to know the reasons why you
need to study it. Let us discuss four reasons:

• To be able to manage money or financial resources. Economics underscores that

a resource is something that is scarce. As such, they have to be managed
properly to maximize their use. This is true for money or any financial resource,
for very often, they are limited and you do not have the luxury of opportunities
to expose them to risk. For many, the money that they will be investing in a
start-up business is the only resource that they have and that they cannot afford
not to have a fail-safe just in case the business does not work out as planned.
• To be able to make sound economic decisions. Decisions being made by
individuals, businesses, and governments affect the entire economy. Due to this,
they must be able to make decisions that increase the value of their stakeholders.
Economically, a lot are at stake in every decision they make. As discussed earlier,
criteria and considerations must be set before making financial decisions because
they influence policies that are being instituted in these entities.
• To be able to arrive at sound personal and business investment decisions. This
reason emphasizes that when individuals and businesses make investment

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 decisions, they have to do this with much prudence. Prudence requires a careful
assessment of the situation, a consideration of the available alternatives, and a
sensitivity analysis highlighting pessimistic and optimistic scenarios. Moreover, a
clear understanding of “what’s in it for me” and for other results in an inclusive
decision that takes into consideration all of the stakeholders.
• To be able to understand the career path available to finance professionals.
Knowing finance entails knowing as well the job opportunities available to
finance professionals. From the various industries where they can start to
specific disciplines they can focus on, candidates must have a thorough
understanding of what finance professionals do and how they can contribute to
the business or to the economy. There are career opportunities in the commerce
and industry, in the government, and in the academe.

Careers in Finance

You can imagine yourself being on top of your career as a finance professional. Be the
chief executive officer (CEO) or the chief financial officer (CFO) of a global company,
the cabinet member in-charge of finance or budget and management of the
government, or the dean of an internationally-recognized finance university. Beginning
with an end in mind, you know that you have to start somewhere.
• Commerce and industry

Financial analyst – evaluating financial performance and preparing financial plans

(you may want to pursue taking the Chartered Financial Analyst [CFA]
professional qualification exam, an international certification)

Cash Management analyst – monitoring daily cash inflows and outflows

Capital expenditures analyst – estimating cash flows and evaluating asset

investment opportunities

Credit analyst – evaluating credit applications

Loan analyst – evaluating consumer and commercial loan applications

Bank teller – assisting customers with their banking transactions

Investment researcher – conducting research on investment opportunities

Insurance agent – selling insurance policies to individuals and businesses and

assisting them in the processing of claims

Real estate agent – marketing, selling, or leasing residential or commercial

properties

Stockbroker – assisting clients in purchasing stocks and bonds and building

investment wealth

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 Security analyst – analyzing and making recommendations on the investment
potential of specific securities

• Government
Administrative clerk – assisting in daily unit administration functions
Examiner – performing compliance field work
• Academe
Lecturer – teaching basic finance subjects
Research assistant – assisting lead researchers in data gathering

The Financial Environment

Understanding business finance requires an appreciation of the financial environment.

The financial environment is characterized by its three interacting areas. These areas
are 1.) financial institutions and markets; 2.) investments; and 3.) financial
management.

The first area involves financial institutions and financial markets. Financial institutions
are organizations or intermediaries that help the financial system operate efficiently and
transfer funds from depositors and investors to individuals, businesses, and
governments that seek to spend or invest the funds in tangible assets. These
organizations provide financial services by dealing with the management of money.
They include banks, insurance companies, and lending institutions. To facilitate
operation and transfer of financial resources, financial markets play an important role.
Financial market is a broad term that describes any market place where trading of
securities such as shares, bonds and currencies occurs. Financial markets take the form
of either a physical or electronic medium. In the Philippines, we have the Philippine
Stock Exchange (PSE).

The second area is investments. This area focuses on the decisions made by businesses
and individuals as they choose securities for their investment portfolios. This involves
the sale or marketing of securities, the analysis of securities, and the management of
investment risks through portfolio diversification.

The third area is financial management. It involves financial planning, asset

management, and decisions to increase the value of the stakeholders. This area is often
attributed to business finance because it deals with decisions concerning cash flows,
including both inflows and outflows. Decisions can range from the strategic (like
business expansions – choosing what types of securities to issue to finance such
expansions) – to operational (like how much cash or inventory the business should
carry). This role primarily rests on the financial manager of the business.

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Financial Instruments and Securities

In the decision of financial management, the term “securities” was mentioned. You
might be wondering “what exactly are securities and why do companies issue them?”
The answer is simple.

Let us discuss securities in the light of financial instruments. A financial instrument is

any physical or electronic document that has intrinsic monetary value or transfer value.
This instrument gives rise to an asset or liability depending upon which entity you are
taking. This gives rise to an asset on the side of the holder or investor, and a liability or
equity on the side of the issuer.

Securities are primarily issued by corporations to generate cash or to acquire an asset.

It could either take the form of a debt security or an equity security. Debt security
refers to corporate bonds (or liability securities) while equity security refers to
corporation shares. A share represents an ownership interest in a corporation.
Corporations may issue either ordinary or preference shares.

Various Financial Institutions or Intermediaries

Financial institutions include banks, insurance companies, and lending institutions,

among others. Let us discuss each of these.
• Banks – supervised and regulated by the Bangko Sentral ng Pilipinas (BSP), an
establishment for the deposit, custody, and issue of money, for making loans
and for making the exchange of funds easier.
Universal and commercial banks – represent the largest single group, resource-
wise, of financial institutions in the Philippines. They accept deposits and make loans to
individuals and businesses. In addition, they are authorizes to engage in underwriting
and other functions of investment houses, and to invest in equities
of non-allied undertakings.
Thrift banks – represent noncommercial banks composed of savings and
mortgage banks, private development banks, stock savings and loan associations
and microfinance thrift banks. They accumulate savings of depositors and invest
them. They also provide short-term working capital and medium- and long- term,
financing to businesses engaged in agriculture, services, industry and housing,
and diversified financial and allied services, and to their chosen markets and
constituencies, especially micro, small and medium enterprises and individuals.
Savings banks – accept the savings of individuals and lend pooled savings to
individuals primarily in the form of mortgage loans.
Rural and cooperative banks- represent the more popular type of banks in the
rural communities. Their role is to promote and expand the rural economy in an
orderly and effective manner by providing the people in the rural communities with
basic financial services. Rural banks are privately owned by cooperatives r
federations of cooperatives.
• Insurance companies – supervised and regulated by the Insurance Commission,
these are companies that offer insurance policies to the public, either by selling

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 directly to an individual or through another source. Comprised of multiple
insurance agents, they can specialized in a particular type or types of insurance
such as life insurance , non-life insurance, health insurance, or auto insurance,
among others.
• Lending institutions- similar to non-banks with quasi-banking functions, they
make loans available to individuals and businesses.
Various Financial Markets
Financial markets are physical or electronic media that facilitate the flow of funds
among individuals, businesses, and governments. Let us discuss the types of
financial markets and securities that may be traded under them.
• Money markets are the markets in which debt securities with maturities of
one year or less are traded.
• Capital markets are the markets in which debt instruments with maturities
longer that one year and equity securities are traded.
• Primary markets are markets in which financial instruments and securities are
initially offered or sold with the proceeds going to the issuer.
• Secondary markets are markets in which previously issued instruments or
securities are traded. In these markets, proceeds go to the current seller
which is not necessarily the issuing corporation. The subtypes under these
markets are:
– Securities markets – where previously issued debt and equity securities
are sold and traded.
• Mortgage markets – where mortgage instruments or loans, backed by real
property in the form of buildings and houses, are originated and traded
• Derivatives markets – where derivative securities are purchased and sold
• Currency exchange markets – also called foreign exchange (FOREX)
market where banks and institutional traders buy and sell various
currencies on behalf of business and other clients.

Finance in Other Areas

Finance also complements other functions of business such as management, marketing,

accounting, information and communication technology, and economics. You will notice
that these areas correspond to other subjects that are part of the FABM track.
Managers and personnel under these areas should have at least a general
understanding of finance concepts to make informed decisions in their areas.

Financial Management in an Organization

Finance is among the core functions of a business. Depending on the size of the
business, finance is always headed by a financial manager. For smaller businesses, this
financial manager may be a supervisor who is reporting to the business owner and for
bigger businesses, he or she may be a vice president reporting to the president.
The task of the financial manager is to ensure that financial decisions are made
with due regard to prudent use of financial resources in the hope of increasing
stakeholder value. Doing it in the most honest and ethical way, increasing stakeholder

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value should be underscored in the light of corporate governance. Corporate
governance deals with the set of rules that an entity observes when conducting
business. Good corporate governance provided stakeholders with information on how
executives or management run the business and who is accountable for important
decisions.
There are usually two managers reporting to the vice president for finance. They
are the treasure and the controller. The treasurer oversees the traditional functions of
financial analysis such as capital budgeting, short-term and long-term financing
decisions, and assets management. On the other hand, the controller usually manages
accounting, cost analysis, and tax planning. Overseeing the functions of these two
managers also implies that their tasks should be aligned with the financial manager’s
primary activities in an organization.

The Financial Manager and the Organizational Goals

A business may take any form of organization such as sole proprietorship, partnership,
or corporation. It could also be engaging in service, merchandising, or manufacturing.
In this regard, one entity’s primary goal may significantly differ from another entity’s
primary goal. But nevertheless, one thing should be common and certain. That is to
increase stakeholder value with due consideration to the risk and timing associated with
expected cash flows. Along the line, the objectives of the entity’s core functions must
be directed at contributing to the achievement of this common goal. This is goal
congruence.
As the head of the finance function, the financial manager must ensure that
financial resources are being used to increase stakeholder value. Capital budgeting,
short-term and long-term financing decisions, asset management, accounting, cost
analysis, and tax planning must be thoughtfully carried out to achieve such goal.
Specific, aligned, and measureable financial objectives must be set and periodically
reviewed. Financial decisions and results of these decisions must also be evaluated to
determine if there are gaps. Thereafter, recommendations must be made to narrow
down and eventually close out the gaps.

Discussion Questions

• What is finance?

• Why do we need to study finance?

• What was the most recent financial decision you made? What were the factors
that you considered in making that decision?

• Do you agree that all people need money to live? Why or why not?

• What is money? Explain in three basic factions.

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 • Discus the three important concepts that must be remembered in making sound
financial decisions.

• Describe the career options available to anyone who wants to pursue finance.
Which among these options interest you? Why?

• Explain how the financial environment operates.

• Describe the three areas that characterize the financial environment.

• What is a financial instrument?

• Compare and contrast debt security and equity security.

• Why are financial institutions important?

• What is a bank?

• Differentiate universal and commercial banks, thrift banks, and rural and
cooperative banks. Provide two examples each.

• How does an insurance company work? Provide twice examples of an insurance

company.

• What are lending institutions? Research on how they accumulate funds to be

availed for as loan.

• What are financial markets?

• Differentiate money markets and capital markets.

• Differentiate primary markets and secondary markets.

• Describe the four types of secondary markets.

• Is financial important to other functions of business? Why or why not?

• Who is responsible for financial management within an organization?

• Explain the importance of corporate governance.

• Explain how a financial manager oversees the cash flow (inflow and outflow) in
an organization.

• What are the primary tasks of a financial manager?

• Differential treasurer and controller.

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 • In what ways can the financial manager help in achieving the goal of the
organization?

• Describe the main objective of the financial manager.

• Discuss goal congruence.

• How can the financial manager ensure that financial objectives are aligned with
the organizational goal?

True or False – I

On the space provided, write TRUE if the idea being expressed is correct and FALSE,
if otherwise.

__________1. Understanding financial entails an understanding of the financial

environment.

2. The concepts of finance are only applicable to established

businesses.

__________3. Finance and account are synonymous.

__________4. Finance is concerned about how the players in a financial system

acquire, spend, manage, and make other sound financial decisions concerning
money and other financial resources.

__________5. Money is anything generally accepted as a means of paying for

goods and services and for paying off debts, or liabilities.

__________6. Riskier assets are more valuable than or preferred to less-risky

assets.

7. Only working individuals, entrepreneurs and businesses make

financial decisions.

8. Financial decisions made by individuals and businesses have

effect on the economy.

__________ _9. Career opportunities in financial are limited to commerce and

industry and the government.

10. A financial professional with a CFA qualification can only practice

or work in the Philippines.

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 True or False –II

On the space provided, write TRUE if the idea being expressed is correct and FALSE,
if otherwise.

__________ 1. Financial institutions and financial markets are one and the same.

__________ 2. Banks and insurance companies are examples of financial

intermediaries.

__________ 3. Financial markets are only limited to physical locations.

__________ 4. Prices, and not risks, are factored in when selling and buying
investments.

__________ 5. Financial management aims to make sound decisions that increase

the value of the stakeholders.

__________ 6. Financial instruments are always physical documents that have

intrinsic monetary value or transfers value.

__________ 7. Financial instruments always give rise to a financial asset and a

financial liability.

__________ 8. Securities, as financial instruments, are only limited to debt

security.

__________ 9. A share represents an ownership interest in a corporation.

_________ 10. Corporations only issue one class of share which is ordinary share.

Matching Type –I

The terms labeled A to J are the ones being described in the sentences numbered 1
to 10. Match each term with the correct sentence.

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 A. Bank F. Money markets

B. Capital markets G. Rural and cooperative banks

C. Financial markets H. Savings banks

D. Insurance companies I. Thrift banks

E. Le ding institutions J. Universal and commercial banks

1. It refers to an establishment for the deposit, custody, and issue

of money, for making loans and discounts, and for making the exchange of funds
easier.

2. They represent noncommercial banks.

3. They accept the savings of individuals and lend pooled savings to

individuals primarily in the form of mortgage loans.

4. They represent the largest single group, resource-wise, of

financial institutions in the Philippines.

5. They can specialize in a particular type or types such as life,

non-life, health, or auto.

6. They represent the more popular type of banks in the rural

communities.

_________ 7. They are similar to non-banks with quasi-banking functions.

__________ 8. They refer to physical or electronic media that facilitate the flow of
funds among individuals, businesses, and governments.

_________ _9. In these markets, debt securities with maturities of one year or less
are traded.

_________10. In these markets, debt instruments with maturities longer than one
year and equity securities are traded.

Matching Type –II

The terms labeled A to J are the ones being described in the sentences numbered 1
to 10. Match each term with the correct sentence.

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 A. Controller F. Mortgage market

B. Corporate governance G. Primary markets

C. Currency exchange market H. Secondary markets

D. Derivatives market I. Securities market

E. Goal congruence J. Treasurer

__________ 1. The objectives of the entity’s core functions must be directed at

contributing to the achievement of the common goal.

__________ 2. The one directly responsible to oversees accounting, cost analysis,

and tax planning.

__________ 3. The one directly responsible to oversees the traditional functions of

financial analysis such as capital budgeting, short-term and long-term financing
decisions, and asset management.

__________ 4. It deals with the set of rules that an entity observes when
conducting business.

__________ 5. Markets in which financial instruments and securities are initially

offered or sold with the proceeds going to the issuer.

__________ 6. In these markets, proceeds go to the current seller which is not

necessarily the issuing corporation.

__________ 7. A subtype of secondary market, it is where previously issued debt

and equity securities are sold and traded.

__________ 8. A subtype of secondary market, it is where banks and institutional

traders buy and sell various currencies on behalf of business and other clients.

__________ 9. A subtype of secondary market, it is where mortgage instruments

or loans, backed by real property in the form of buildings and houses, are originated
and traded.

_________ 10. A subtype of secondary market, it is where derivative securities are

purchased and sold.

Multiple Choice.

Circle the choice that corresponds to the best answer.

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 1. Money performs all of the following functions except

a. Serves as an asset of the government

b. May be held as a store of value

c. Serves as a standard of value

d. Serves as a medium of exchange

2. In making sound financial decisions, the following concepts must be remembered

except

a. More value is preferred to less.

b. The later the cash is received, the more valuable it is.

c. Less-risky assets are more valuable than or preferred to riskier assets.

d. In terms of cash, delayed gratification is ignored.

3. Finance is worth studying because

a. it guarantees increase in stakeholder value.

b. it will make you rich

c. it will enabled you to make correct financial decisions at all times

d. it will enable you to understand career options available to finance

professionals.

4. Career options available to finance professionals include the following except

a. Dean of finance school

b. CFO of a global enterprise

b. Bureau of Internal Revenue (BIR) Collections Officer

d. None of the above

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 5. It facilities operation and transfer of financial resources in the financial
environment.

a. Financial institutions

b. Financial markets

c. Investments

d. Financial management

6. It involves the sale or marketing of securities, the analysis of securities, and the
management of investment risk through portfolio diversification

a. Financial institutions

b. Financial markets

c. Investments

d. Financial management

7. This role primarily rest on the financial manager of the business.

a. Decisions concerning cash flows

b. Choosing what types of securities to issue to finance expansions

c. Deciding on how much cash or inventory the business should carry

d. All of the above

8. To the issuing entity, securities as financial instruments give rise to

a. Financial liability or equity

b. Financial asset

c. Both financial liability and financial asset

d. It depends

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 9. Banks in the Philippines are supervised and regulated by the

a. Bangko Sentral ng Pilipinas

b. Insurance Commission

c. Local government unit

d. Department of Finance

10.Which of the following are not thrift banks?

a. Savings and mortgage banks

b. Stock savings and loan associations banks

c. Rural banks

d. Private development

Week 2: What is Money?

Money makes the world go around. Economies rely on the exchange of money for
products and services. Economists define money, where it comes from, and what it's
worth. Here are the multifaceted characteristics of money.

• Money is a medium of exchange; it allows people to obtain what they need to

live.
• Bartering was one way that people exchanged goods for other goods before
money was created.
• Like gold and other precious metals, money has worth because for most people
it represents something valuable.
• Fiat money is government-issued currency that is not backed by a physical
commodity but by the stability of the issuing government.
Medium of Exchange

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Before the development of a medium of exchange—that is, money—people would barter
to obtain the goods and services they needed. Two individuals, each possessing some
goods the other wanted, would enter into an agreement to trade.
Early forms of bartering, however, do not provide the transferability and divisibility that
makes trading efficient. For instance, if someone has cows but needs bananas, they
must find someone who not only has bananas but also the desire for meat. What if that
individual finds someone who has the need for meat but no bananas and can only offer
potatoes? To get meat, that person must find someone who has bananas and wants
potatoes, and so on.
The lack of transferability of bartering for goods is tiring, confusing, and inefficient. But
that is not where the problems end; even if the person finds someone with whom to
trade meat for bananas, they may not consider a bunch of bananas to be worth a whole
cow. Such a trade requires coming to an agreement and devising a way to determine
how many bananas are worth certain parts of the cow.
Commodity money solved these problems. Commodity money is a type of good that
functions as currency. In the 17th and early 18th centuries, for example, American
colonists used beaver pelts and dried corn in transactions.1 Possessing generally
accepted values, these commodities were used to buy and sell other things. The
commodities used for trade had certain characteristics: they were widely desired and,
therefore, valuable, but they were also durable, portable, and easily stored.
Another, more advanced example of commodity money is a precious metal such as gold.
For centuries, gold was used to back paper currency—up until the 1970s.2 In the case
of the U.S. dollar, for example, this meant that foreign governments were able to take
their dollars and exchange them at a specified rate for gold with the U.S. Federal
Reserve. What's interesting is that, unlike the beaver pelts and dried corn (which can
be used for clothing and food, respectively), gold is precious purely because people
want it. It is not necessarily useful—you can't eat gold, and it won't keep you warm at
night, but the majority of people think it is beautiful, and they know others think it is
beautiful. So, gold is something that has worth. Gold, therefore, serves as a physical
token of wealth based on people's perceptions.
This relationship between money and gold provides insight into how money gains its
value—as a representation of something valuable.

Impressions Create Everything

The second type of money is fiat money, which does not require backing by a physical
commodity. Instead, the value of fiat currencies is set by supply and demand and
people's faith in its worth. Fiat money developed because gold was a scarce resource,
and rapidly growing economies growing couldn't always mine enough to back their
currency supply requirements.3 4 For a booming economy, the need for gold to
give money value is extremely inefficient, especially when its value is really created by
people's perceptions.

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Fiat money becomes the token of people's perception of worth, the basis for why
money is created. An economy that is growing is apparently succeeding in producing
other things that are valuable to itself and other economies. The stronger the economy,
the stronger its money will be perceived (and sought after) and vice versa. However,
people's perceptions must be supported by an economy that can produce the products
and services that people want.
For example, in 1971, the U.S. dollar was taken off the gold standard—the dollar was
no longer redeemable in gold, and the price of gold was no longer fixed to any dollar
amount.This meant that it was now possible to create more paper money than there
was gold to back it; the health of the U.S. economy backed the dollar's value. If the
economy stalls, the value of the U.S. dollar will drop both domestically through inflation
and internationally through currency exchange rates. The implosion of the U.S.
economy would plunge the world into a financial dark age, so many other countries and
entities are working tirelessly to ensure that never happens.
Today, the value of money (not just the dollar, but most currencies) is decided purely
by its purchasing power, as dictated by inflation. That is why simply printing new
money will not create wealth for a country. Money is created by a kind of a perpetual
interaction between real, tangible things, our desire for them, and our abstract faith in
what has value. Money is valuable because we want it, but we want it only because it
can get us a desired product or service.

How Is Money Measured?

But exactly how much money is out there, and what forms does it take? Economists
and investors ask this question to determine whether there is inflation or deflation.
Money is separated into three categories so that it is more discernible for measurement
purposes:

M1 – This category of money includes all physical denominations of coins and currency;
demand deposits, which are checking accounts and NOW accounts; and travelers'
checks. This category of money is the narrowest of the three, and is essentially the
money used to buy things and make payments (see the "active money" section below).
M2 – With broader criteria, this category adds all the money found in M1 to all time-
related deposits, savings accounts deposits, and non-institutional money market funds.
This category represents money that can be readily transferred into cash.
M3 – The broadest class of money, M3 combines all money found in the M2 definition
and adds to it all large time deposits, institutional money market funds, short-term
repurchase agreements, along with other larger liquid assets.
By adding these three categories together, we arrive at a country's money supply or
the total amount of money within an economy.

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Active Money
The M1 category includes what's known as active money—the total value of coins and
paper currency in circulation. The amount of active money fluctuates seasonally,
monthly, weekly, and daily. In the United States, Federal Reserve Banks distribute new
currency for the U.S. Treasury Department. Banks lend money out to customers, which
becomes active money once it is actively circulated.

The variable demand for cash equates to a constantly fluctuating active money total.
For example, people typically cash paychecks or withdraw from ATMs over the weekend,
so there is more active cash on a Monday than on a Friday. The public demand for cash
declines at certain times—following the December holiday season, for example.6

How Money Is Created

We have discussed why and how money, a representation of perceived value, is created
in the economy, but another important factor concerning money and the economy is
how a country's central bank (the central bank in the United States is the Federal
Reserve or the Fed) can influence and manipulate the money supply.

If the Fed wants to increase the amount of money in circulation, perhaps to boost
economic activity, the central bank can, of course, print it. However, the physical bills
are only a small part of the money supply.

Another way for the central bank to increase the money supply is to buy government
fixed-income securities in the market. When the central bank buys these government
securities, it puts money into the marketplace, and effectively into the hands of the
public. How does a central bank such as the Fed pay for this? As strange as it sounds,
the central bank simply creates the money and transfers it to those selling the
securities. Alternatively, the Fed can lower interest rates allowing banks to extend low-
cost loans or credit—a phenomenon known as cheap money—and encouraging
businesses and individuals to borrow and spend.

To shrink the money supply, perhaps to reduce inflation, the central bank does the
opposite and sells government securities. The money with which the buyer pays the
central bank is essentially taken out of circulation. Keep in mind that we are
generalizing in this example to keep things simple.

The 4 Functions of Money

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The following points highlight the top four functions of money. The functions are: 1. A
Medium of Exchange 2. A Measure of Value or Unit of Account or Means of Valuation 3.
Store of Value 4. Standard of Deferred Payment.

1. A Medium of Exchange:
Money serves as a medium of exchange for all kinds of goods and services. Money
facilitates both buying and selling of goods and services. Today’s modern economy—
based on specialization and division of labour—cannot be imagined in the absence of a
generally acceptable medium of exchange.

Suppose, a shopkeeper likes to pay ten kilograms of detergent to his workers as wages.
Now this worker will have to search people who are in need of this product. Such job is
not only time-consuming but also impossible. Thus, under barter system, transaction
cost—the time spent for exchange of goods and services—is very high since people will
have to satisfy “double coincidence of wants”.

This means that all people will have to find someone who has a good that they want
and who want to get the service or good they have to offer. If money is used to pay
wages then no one will grudge. In other words, if money is used as a medium of
exchange then this difficulty is automatically removed.

To act as an ideal medium of exchange, money should have the following attributes:

General acceptability, portability, divisibility, durability, stability of value, homogeneity,

etc.

2. A Measure of Value or Unit of Account or Means of Valuation:

Money acts as a unit of account or money is the measure of exchange value. This
means that money is a sort of common denominator, through which the exchange
value of all goods and services can be expressed without any difficulty. Innumerable
exchange rates under the barter system earlier caused enormous trouble in the
transactions of all kinds.

Money has removed this difficulty by serving as a common measure of value. The value
of all goods and services is expressed in terms of price and prices are expressed in
terms of money. As money acts as a unit of account it has greatly reduced the number
of exchange rates.

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Further, since the value of all commodities is expressed in terms of money, one can
compare the values of commodities. Suppose, the price of commodity X is Rs. 5 while
that of Y is Rs. 10. Thus, Y is twice as expensive as X. This means that money serves as
a measure of value. Money also enables dissimilar things such as a person’s car or real
estate to be added up. National income is also expressed in terms of money.

3. Store of Value:
Money also serves as a store of value. It is a ‘repository of purchasing power over time’.
A store of value i.e., money is used to save purchasing power from the time income is
received until the time it is spent. Money is one such medium in which one wishes to
hold wealth. Money is thus a means of saving.

Because of perfect liquidity, money acts a store of value. By liquidity, we mean

convertibility of assets into cash. Money, like bonds, government securities etc. is an
asset because it is a claim. Money being the most liquid asset among all assets (stocks,
lands, jewellery, etc.) people prefer to keep their assets in the form of money. Liquid
assets facilitate transactions of all kinds of goods and services.

4. Standard of Deferred Payment:

Lending and borrowing virtually come to halt in a moneyless economy. With the
introduction of money, borrowing and lending have become easier. With the expansion
of trade and commerce based on credit, money has become a standard of deferred
payments. Deferred payments are those which are postponed for the future. Money
enables current transactions to be discharged in future.

1. Metaphysics
1.1 What is Money?
Money is so ever-present in modern life that we tend to take its existence and nature
for granted. But do we know what money actually is? Two competing theories present
fundamentally different ontologies of money.

The commodity theory of money: A classic theory, which goes back all the way to
Aristotle (Politics, 1255b–1256b), holds that money is a kind of commodity that fulfills
three functions: it serves as (i) a medium of exchange, (ii) a unit of account, and (iii) a
store of value. Imagine a society that lacks money, and in which people have to barter
goods with each other. Barter only works when there is a double coincidence of wants;
that is, when A wants what B has and B wants what A has. But since such coincidences

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are likely to be uncommon, a barter economy seems both cumbersome and inefficient
(Smith 1776, Menger 1892). At some point, people will realize that they can trade more
easily if they use some intermediate good—money. This intermediate good should
ideally be easy to handle, store and transport (function i). It should be easy to measure
and divide to facilitate calculations (function ii). And it should be difficult to destroy so
that it lasts over time (function iii).

Monetary history may be viewed as a process of improvement with regard to these

functions of money (Ferguson 2008, Weatherford 1997). For example, some early
societies used certain basic necessities as money, such as cattle or grain. Other
societies settled on commodities that were easier to handle and to tally but with more
indirect value, such as clamshells and precious metals. The archetypical form of money
throughout history are gold or silver coins—therefore the commodity theory is
sometimes called metallism (Knapp 1924, Schumpeter 1954). Coinage is an
improvement on bullion in that both quantity and purity are guaranteed by some third
party, typically the government. Finally, paper money can be viewed as a simplification
of the trade in coins. For example, a bank note issued by the Bank of England in the
1700s was a promise to pay the bearer a certain pound weight of sterling silver (hence
the origin of the name of the British currency as “pounds sterling”).

The commodity theory of money was defended by many classical economists and can
still be found in most economics textbooks (Mankiw 2009, Parkin 2011). This latter fact
is curious since it has provoked serious and sustained critique. An obvious flaw is that it
has difficulties in explaining inflation, the decreasing value of money over time (Innes
1913, Keynes 1936). It has also been challenged on the grounds that it is historically
inaccurate. For example, recent anthropological studies question the idea that early
societies went from a barter economy to money; instead money seems to have arisen
to keep track of pre-existing credit relationships (Graeber 2011, Martin 2013, Douglas
2016, Part III).

The credit theory of money: According to the main rival theory, coins and notes are
merely tokens of something more abstract: money is a social construction rather than a
physical commodity. The abstract entity in question is a credit relationship; that is, a
promise from someone to grant (or repay) a favor (product or service) to the holder of
the token (Macleod 1889, Innes 1914, Ingham 2004). In order to function as money,
two further features are crucial: that (i) the promise is sufficiently credible, that is, the
issuer is “creditworthy”; and (ii) the credit is transferable, that is, also others will
accept it as payment for trade.

It is commonly thought that the most creditworthy issuer of money is the state. This
thought provides an alternative explanation of the predominance of coins and notes
whose value is guaranteed by states. But note that this theory also can explain so-

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called fiat money, which is money that is underwritten by the state but not redeemable
in any commodity like gold or silver. Fiat money has been the dominant kind of money
globally since 1971, when the United States terminated the convertibility of dollars to
gold. The view that only states can issue money is called chartalism, or the state theory
of money (Knapp 1924). However, in order to properly understand the current
monetary system, it is important to distinguish between states’ issuing versus
underwriting money. Most credit money in modern economies is actually issued by
commercial banks through their lending operations, and the role of the state is only to
guarantee the convertibility of bank deposits into cash (Pettifor 2014).

Criticisms of the credit theory tend to be normative and focus on the risk of
overexpansion of money, that is, that states (and banks) can overuse their “printing
presses” which may lead to unsustainable debt levels, excessive inflation, financial
instability and economic crises. These are sometimes seen as arguments for a return to
the gold standard (Rothbard 1983, Schlichter 2014). However, others argue that the
realization that money is socially constructed is the best starting point for developing a
more sustainable and equitable monetary regime (Graeber 2010, Pettifor 2014). We will
return to this political debate below (section 5.2).

The social ontology of money: But exactly how does the “social construction” of money
work? This question invokes the more general philosophical issue of social ontology,
with regard to which money is often used as a prime example. An influential account of
social ontology holds that money is the sort of social institution whose existence
depends on “collective intentionality”: beliefs and attitudes that are shared in a
community (see, e.g., Searle 1995, 2010; Smit, Buekens, & du Plessis 2011). The
process starts with someone’s simple and unilateral declaration that something is
money, which is a performative speech act (see Austin 1962). When other people
recognize or accept the declaration it becomes a standing social rule. Thus, money is
said to depend on our subjective attitudes but is not located (solely) in our minds (for a
discussion see also the entries on social ontology and social institutions). In an early
philosophical-sociological account, Georg Simmel (1900) had described money as an
institution that is a crucial precondition for modernity because it allows putting a value
on things and simplifies transactions; he also criticizes the way in which money thereby
replaces other forms of valuation (see also section 4.1).

1.2 What is Finance?

One may view “finance” more generally (that is, the financial sector or system) as an
extension of the monetary system. It is typically said that the financial sector has two
main functions: (1) to maintain an effective payments system; and (2) to facilitate an
efficient use of money. The latter function can be broken down further into two parts.
First, to bring together those with excess money (savers, investors) and those without
it (borrowers, enterprises), which is typically done through financial intermediation (the
inner workings of banks) or financial markets (such as stock or bond markets). Second,

BUSFIN 24
to create opportunities for market participants to buy and sell money, which is typically
done through the invention of financial products, or “assets”, with features
distinguished by different levels of risk, return, and maturation.

The modern financial system can thus be seen as an infrastructure built to facilitate
transactions of money and other financial assets, as noted at the outset. It is important
to note that it contains both private elements (such as commercial banks, insurance
companies, and investment funds) and public elements (such as central banks and
regulatory authorities). “Finance” can also refer to the systematic study of this system;
most often to the field of financial economics (see section 3).

Financial assets: Of interest from an ontological viewpoint is that modern finance

consists of several other “asset types” besides money; central examples include credit
arrangements (bank accounts, bonds), equity (shares or stocks), derivatives (futures,
options, swaps, etc.) and funds (trusts). What are the defining characteristics of
financial assets?

The typical distinction here is between financial and “real” assets, such as buildings and
machines (Fabozzi 2002), because financial assets are less tangible or concrete. Just
like money, they can be viewed as a social construction. Financial assets are often
derived from or at least involve underlying “real” assets—as, for example, in the
relation between owning a house and investing in a housing company. However,
financial transactions are different from ordinary market trades in that the underlying
assets seldom change hands, instead one exchanges abstract contracts or promises of
future transactions. In this sense, one may view the financial market as the “meta-
level” of the economy, since it involves indirect trade or speculation on the success of
other parts of the economy.

More distinctly, financial assets are defined as promises of future money payments
(Mishkin 2016, Pilbeam 2010). If the credit theory of money is correct, they can be
regarded as meta-promises: promises on promises. The level of abstraction can
sometimes become enormous: For example, a “synthetic collateralized debt obligation”
(or “synthetic CDO”), a form of derivative common before the financial crisis, is a
promise from person A (the seller) to person B (the buyer) that some persons C to I
(speculators) will pay an amount of money depending on the losses incurred by person
J (the holder of an underlying derivative), which typically depend on certain portions
(so-called tranches) of the cash flow from persons K to Q (mortgage borrowers)
originally promised to persons R to X (mortgage lenders) but then sold to person Y (the
originator of the underlying derivative). The function of a synthetic CDO is mainly to
spread financial risks more thinly between different speculators.

BUSFIN 25
Intrinsic value: Perhaps the most important characteristic of financial assets is that
their price can vary enormously with the attitudes of investors. Put simply, there are
two main factors that determine the price of a financial asset: (i) the credibility or
strength of the underlying promise (which will depend on the future cash flows
generated by the asset); and (ii) its transferability or popularity within the market, that
is, how many other investors are interested in buying the asset. In the process known
as “price discovery”, investors assess these factors based on the information available
to them, and then make bids to buy or sell the asset, which in turn sets its price on the
market (Mishkin 2016, Pilbeam 2010).

A philosophically interesting question is whether there is such a thing as an “intrinsic”

value of financial assets, as is often assumed in discussions about financial crises. For
example, a common definition of an “asset bubble” is that this is a situation that occurs
when certain assets trade at a price that strongly exceed their intrinsic value—which is
dangerous since the bubble can burst and cause an economic shock (Kindleberger 1978,
Minsky 1986, Reinhart & Rogoff 2009). But what is the intrinsic value of an asset? The
rational answer seems to be that this depends only on the discounted value of the
underlying future cash flow—in other words, on (i) and not (ii) above. However,
someone still has to assess these factors to compute a price, and this assessment
inevitably includes subjective elements. As just noted, it is assumed that different
investors have different valuations of financial assets, which is why they can engage in
trades on the market in the first place.

A further complication here is that (i) may actually be influenced by (ii). The
fundamentals may be influenced by investors’ perceptions of them, which is a
phenomenon known as “reflexivity” (Soros 1987, 2008). For example, a company
whose shares are popular among investors will often find it easier to borrow more
money and thereby to expand its cash flow, in turn making it even more popular among
investors. Conversely, when the company’s profits start to fall it may lose popularity
among investors, thereby making its loans more expensive and its profits even lower.
This phenomenon amplifies the risks posed by financial bubbles (Keynes 1936).

2. Epistemology
Given the abstractness and complexity of financial assets and relations, as outlined
above, it is easy to see the epistemic challenges they raise. For example, what is a
proper basis for forming justified beliefs about matters of money and finance?

A central concept here is that of risk. Since financial assets are essentially promises of
future money payments, a main challenge for financial agents is to develop rational
expectations or hypotheses about relevant future outcomes. The two main factors in
this regard are (1) expected return on the asset, which is typically calculated as the
value of all possible outcomes weighted by their probability of occurrence, and (2)

BUSFIN 26
financial risk, which is typically calculated as the level of variation in these returns. The
concept of financial risk is especially interesting from a philosophical viewpoint since it
represents the financial industry’s response to epistemic uncertainty. It is often argued
that the financial system is designed exactly to address or minimize financial risks—for
example, financial intermediation and markets allow investors to spread their money
over several assets with differing risk profiles (Pilbeam 2010, Shiller 2012). However,
many authors have been critical of mainstream operationalizations of risk which tend to
focus exclusively on historical price volatility and thereby downplay the risk of large-
scale financial crises (Lanchester 2010, Thamotheram & Ward 2014).

This point leads us further to questions about the normativity of belief and knowledge.
Research on such topics as the ethics of belief and virtue epistemology considers
questions about the responsibilities that subjects have in epistemic matters. These
include epistemic duties concerning the acquisition, storage, and transmission of
information; the evaluation of evidence; and the revision or rejection of belief (see also
ethics of belief). In line with a reappraisal of virtue theory in business ethics, it is in
particular virtue epistemology that has attracted attention from scholars working on
finance. For example, while most commentators have focused on the moral failings that
led to the financial crisis of 2008, a growing literature examines epistemic failures.

Epistemic failings in finance can be detected both at the level of individuals and
collectives (de Bruin 2015). Organizations may develop corporate epistemic virtue
along three dimensions: through matching epistemic virtues to particular functions (e.g.,
diversity at the board level); through providing adequate organizational support for the
exercise of epistemic virtue (e.g., knowledge management techniques); and by
adopting organizational remedies against epistemic vice (e.g., rotation policies). Using
this three-pronged approach helps to interpret such epistemic failings as the failure of
financial due diligence to spot Bernard Madoff’s notorious Ponzi scheme (uncovered in
the midst of the financial crisis) (de Bruin 2014a, 2015).

Epistemic virtue is not only relevant for financial agents themselves, but also for other
institutions in the financial system. An important example concerns accounting
(auditing) firms. Accounting firms investigate businesses in order to make sure that
their accounts (annual reports) offer an accurate reflection of the financial situation.
While the primary intended beneficiaries of these auditing services are shareholders
(and the public at large), accountants are paid by the firms they audit. This
remuneration system is often said to lead to conflicts of interest. While accounting
ethics is primarily concerned with codes of ethics and other management tools to
minimize these conflicts of interests, an epistemological perspective may help to show
that the business-auditor relationship should be seen as involving a joint epistemic
agent in which the business provides evidence, and the auditor epistemic justification
(de Bruin 2013). We will return to issues concerning conflicts of interest below (in
section 4.2).

BUSFIN 27
Epistemic virtue is also important for an effective governance or regulation of financial
activities. For example, a salient epistemic failing that contributed to the 2008 financial
crisis seems to be the way that Credit Rating Agencies rated mortgage-backed
securities and other structured finance instruments, and with related failures of financial
due diligence, and faulty risk management (Warenski 2008). Credit Rating Agencies
provide estimates of credit risk of bonds that institutional investors are legally bound to
use in their investment decisions. This may, however, effectively amount to an
institutional setup in which investors are forced by law partly to outsource their risk
management, which fails to foster epistemic virtue (de Bruin 2017). Beyond this,
epistemic failures can also occur among regulators themselves, as well as among
relevant policy makers (see further in section 5.1).

3. Philosophy of Science
Compared to financial practitioners, one could think that financial economists should be
at an epistemic advantage in matters of money and finance. Financial economics is a
fairly young but well established discipline in the social sciences that seeks to
understand, explain, and predict activities within financial markets. However, a few
months after the crash in 2008, Queen Elizabeth II famously asked a room full of
financial economists in London why they had not predicted the crisis (Egidi 2014). The
Queen’s question should be an excellent starting point for an inquiry into the philosophy
of science of financial economics. Yet only a few philosophers of science have
considered finance specifically.[1]

Some important topics in financial economics have received partial attention, including
the Modigliani-Miller capital structure irrelevance theorem (Hindriks 2008), the efficient
market hypothesis (Collier 2011), the Black-Scholes option pricing model (Weatherall
2017), portfolio theory (Walsh 2015), financial equilibrium models (Farmer &
Geanakoplos 2009), the concept of money (Mäki 1997), and behavioral finance (Brav,
Heaton, & Rosenberg 2004), even though most of the debate still occurs among
economists interested in methodology rather than among philosophers. A host of topics
remain to be investigated, however: the concept of Value at Risk (VaR) (and more
broadly the concept of financial risk), the capital asset pricing model (CAPM), the
Gaussian copula, random walks, financial derivatives, event studies, forecasting (and
big data), volatility, animal spirits, cost of capital, the various financial ratios, the
concept of insolvency, and neurofinance, all stand in need of more sustained attention
from philosophers.

Most existing work on finance in philosophy of science is concerned with models and
modelling (see also models in science and philosophy of economics). It seems intuitive
to view financial markets as extremely complex systems: with so many different factors
at play, predicting the price of securities (shares, bonds, etc.) seems almost impossible.

BUSFIN 28
Yet mainstream financial economics is firmly committed to the idea that market
behavior should be understood as ultimately resulting from interactions of agents
maximizing their expected utility. This is a direct application of the so-called
neoclassical school of economics that was developed during the late nineteenth and
early twentieth centuries. While this school continues to dominate textbooks in the field,
there is a growing scholarly trend that seeks to criticize, complement or even replace
some of its main assumptions. We can see how the problems play out in both corporate
finance and asset pricing theory.

Corporate finance concerns the financing of firms. One question concerns a firm’s
capital structure: should a firm obtain funding through equity (that is, from
shareholders expecting dividends) or through debt (that is, from bondholders who lend
money to the firm and have a contractual right to receive interest on the loans), or
through a combination of the two. A key result in corporate finance is the Modigliani-
Miller theorem, which says that a firm’s capital structure is irrelevant to its market
value (Modigliani & Miller 1958). This theorem makes a number of highly unrealistic
assumptions, among them the assumption that markets are efficient, and that there are
no taxes. Alongside many other results in economics, it may therefore be considered as
useless for predictive purposes; or even as dangerous, once used for such purposes
nonetheless (Egidi 2014). In a detailed study of the Modigliani-Miller theorem, Hindriks
(2008) has argued, however, that the value of highly idealized models in economics
may lie in their providing counterfactual insights, just as in physics. Galileo’s law of free
fall tells us what happens in a vacuum. Despite the fact that vacuum is rare in reality,
the law is not uninformative, because it allows us to associate observed phenomena to
the extent to which an unrealistic assumption must be relaxed. Similarly, if one of the
assumptions that the Modigliani-Miller theorem makes is the absence of taxes, the
observed relevance of capital structure may well have to be explained as resulting from
particular tax regimes. The explanation obtained by relaxing unrealistic assumptions is
called “explanation by concretization” (Hindriks 2008).

Explanation by concretization works if models and reality share at least a few concrete
features. This is arguably the case for many extant models in finance, including models
of bubbles and crises that are immediately relevant to explaining the 2008 crisis (Abreu
& Brunnermeier 2003). A fairly recent development called “econophysics” may,
however, be an exception. Econophysics uses physics methods to model financial
markets (see Rickles 2007 for an overview). Where traditional models of crises include
individual investors with beliefs and desires modelled by probability distributions and
utility functions, econophysics models capture crises the way physicists model
transitions of matter from fluid to solid state (Kuhlmann 2014).

Next, consider asset pricing theory. Ever since Bachelier’s groundbreaking

mathematical treatment of asset pricing, financial economists have struggled to find the
best way to determine the price developments of securities such as shares, bonds, and
derivative instruments such as options. The mathematics of financial returns has

BUSFIN 29
received some attention in the literature (de Bruin & Walter 2017; Ippoliti & Chen
2017). Most models assume that returns follow Gaussian random walks, that is,
stochastic processes in discrete time with independent and identically distributed
increments. Empirical studies show, however, that returns are more peaked than
Gaussian distributions, and that they have “fat tails”. This means that extreme events
such as financial crises are far less improbable than the models assume. An exception
with regards to these assumptions is Benoît Mandelbrot’s (1963) well-known
contribution to financial mathematics, and work in this direction is gaining traction in
mathematical finance.

A third aspect of financial models concerns the way they incorporate uncertainty
(Bertolotti & Magnani 2017). Some of the problems of contemporary financial (and
macroeconomic) models are due to the way they model uncertainty as risk, as outlined
above (Frydman & Goldberg 2013). Both neo-classical models and behavioral
economics capture uncertainty as probabilistic uncertainty, consequently ignoring
Knightian uncertainty (Knight 1921 see also decision theory). The philosophy of science
literature that pertains to financial economics is, however, still fairly small.

4. Ethics
Having considered the epistemic and scientific challenges of finance, we now turn to the
broad range of compelling ethical challenges related to money and finance. The present
part is divided into three sections, discussing 1) the claim that financial activities are
always morally suspect, 2) various issues of fairness that can arise in financial markets,
and 3) discussions about the social responsibilities of financial agents.

4.1 Money as the Root of All Evil?

Throughout cultural history, activities that involve money or finance have been subject
to intense moral scrutiny and ethical debate. It seems fair to say that most traditional
ethicists held a very negative attitude towards such activities. We will here discuss
three very sweeping criticisms, respectively directed at the love of money (the profit
motive), usury (lending at interest), and speculation (gambling in finance).

4.1.1 The love of money

At the heart of many sweeping criticisms of money and finance lies the question of
motive. For instance, the full Biblical quotation says that “the love of money is the root
of all [kinds of] evil” (1 Timothy 6:10). To have a “love of money”, or (in less moralistic
words) a profit motive, means to seek money for its own sake. It has been the subject
of much moral criticism throughout history and continues to be controversial in popular
morality.

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There are three main variations of the criticism. A first variation says that there is
something unnatural about the profit motive itself. For example, Aristotle argued that
we should treat objects in ways that are befitting to their fundamental nature, and
since money is not meant to be a good in itself but only a medium of exchange (see
section 1.1), he concluded that it is unnatural to desire money as an end in itself
(Politics, 1252a–1260b). A similar thought is picked up by Marx, who argues that
capitalism replaces the natural economic cycle of C–M–C (commodity exchanged for
money exchanged for commodity) with M–C–M (money exchanged for commodity
exchanged for money). Thus the endless accumulation of money becomes the sole goal
of the capitalist, which Marx describes as a form of “fetishism” (Marx 1867, volume I).

A second variation of the criticism concerns the character, or more precisely the vice,
that the profit motive is thought to exemplify (see also virtue ethics). To have a love for
money is typically associated with selfishness and greed, i.e., a desire to have as much
as possible for oneself and/or more than one really needs (McCarty 1988, Walsh &
Lynch 2008). Another association is the loss of moral scruples so that one is ready to
do anything for money. The financial industry is often held out as the worst in this
regard, especially because of its high levels of compensation. Allegations of greed
soared after the 2008 crisis, when financial executives continued to receive million-
dollar bonuses while many ordinary workers lost their jobs (Piketty 2014, McCall 2010).

A third variation of the criticism says that the profit motive signals the absence of more
appropriate motives. Kant argued that actions only have moral worth if they are
performed for moral reasons, or, more specifically, for the sake of duty. Thus it is not
enough that we do what is right, we must also do it because it is right (Kant 1785).
Another relevant Kantian principle is that we never should treat others merely as
means for our own ends, but always also as ends in themselves (see also Kant’s moral
philosophy). Both of these principles seem to contrast with the profit motive which
therefore is rendered morally problematic (Bowie 1999, Maitland 2002). It should come
as no surprise that Kant was a strong critic of several examples of “commodification”
and other market excesses (see also markets).

There are two main lines of defensive argumentation. The most influential is Adam
Smith’s well-known argument about the positive side-effects of a self-interested pursuit
of profits: although the baker and brewer only aim at their own respective good, Smith
suggested, they are “led by an invisible hand” to at the same time promote the public
good (Smith 1776, see also Mandeville 1732). This argument is typically viewed as a
consequentialist vindication of the profit motive (see also consequentialism): positive
societal effects can morally outweigh the possible shortcomings in individual virtue
(Flew 1976).

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A second argument is more direct and holds that the profit motive can exemplify a
positive virtue. For example, there is the well-known Protestant work ethic that
emphasizes the positive nature of hard work, discipline and frugality (Long 1972,
Wesley 1771). The profit motive can, on this view, be associated with virtues such as
ambition, industry, and discipline. According to Max Weber (1905), the Protestant work
ethic played an important role in the development of capitalism. But it is not clear
whether any of these arguments can justify an exclusive focus on profits, of course, or
rather give permission to also focus on profits under certain circumstances.

4.1.2 Usury and interest

If having a love of money seems morally suspect, then the practice of making money
on money—for instance, lending money at interest—could seem even worse. This is
another sweeping criticism directed at finance that can be found among the traditional
ethicists. Societies in both Ancient and Medieval times typically condemned or banned
the practice of “usury”, which originally meant all charging of interest on loans. As the
practice started to become socially acceptable, usury came to mean the charging of
excessive rates of interest. However, modern Islam still contains a general prohibition
against interest, and many countries still have at least partial usury laws, most often
setting an upper limit on interest rates.

What could be wrong with lending at interest? Some of the more obscure arguments
concern the nature of money (again): Aristotle argued that there is something
unnatural with “money begetting money”. While he allowed that money is a useful
means for facilitating commercial exchange, Aristotle thought that it has no productive
use in itself and so receiving interest over and above the borrowed amount is unnatural
and wrong (Politics, 1258b). A related argument can be found in Aquinas, who argued
that money is a good that is consumed on use. Although a lender can legitimately
demand repayment of an amount equivalent to the loan, it is illegitimate to demand
payment for the use of the borrowed amount and so adding interest is unnatural and
wrong (Summa Theologica, II–II, Q78).

Some more promising arguments concern justice and inequality. For example, as early
as Plato we see the expression of the worry that allowing interest may lead to societal
instability (The Republic, II). It may be noted that the biblical condemnations of usury
most straightforwardly prohibit interest-taking from the poor. One idea here is that we
have a duty of charity to the poor and charging interest is incompatible with this duty.
Another idea is that the problem lies in the outcome of interest payments: Loans are
typically extended by someone who is richer (someone with capital) to someone who is
poorer (someone without it) and so asking for additional interest may increase the
inequitable distribution of wealth (Sandberg 2012, Visser & MacIntosh 1998). A third
idea, which is prominent in the protestant tradition, is that lending often involves
opportunism or exploitation in the sense of offering bad deals to poor people who have
no other options (Graafland 2010).

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The Islamic condemnation of interest, or riba, adds an additional, third line of argument
which holds that interest is essentially unearned or undeserved income: Since the
lender neither partakes in the actual productive use of the money lent, nor exposes
him- or herself to commercial risk, the lender cannot legitimately share in the gains
produced by the loan (Ayub 2007, Birnie 1952, Thomas 2006). Based on this argument,
contemporary Islamic banks insist that lenders and borrowers must form a business
partnership in order for fees on loans to be morally legitimate (Ayub 2007, Warde
2010). Economists have over the years given several retorts to this argument. Some
economists stress that lending also involves risk (e.g., that the borrower defaults and is
unable to repay); others stress the so-called opportunity costs of lending (i.e., that the
money could have been used more profitably elsewhere); and yet again others stress
the simple time-preference of individuals (i.e., that we value present more than future
consumption, and therefore the lender deserves compensation for postponing
consumption).

The gradual abandonment of the medieval usury laws in the West is typically attributed
to a growing acknowledgment of the great potential for economic growth unleashed by
easy access to capital. One could perhaps say that history itself disproved Aristotle:
money indeed proved to have a productive use. In a short text from 1787, Bentham
famously poked fun at many of the classical anti-usury arguments and defended the
practice of charging interest from a utilitarian standpoint (Bentham 1787). However,
this does not mean that worries about the ethics of charging interest, and allegations of
usury, have disappeared entirely in society. As noted above, usury today means
charging interest rates that seem excessive or exorbitant. For instance, many people
are outraged by the rates charged on modern payday loans, or the way in which rich
countries exact interest on their loans from poor countries (Baradaran 2015, Graeber
2011, Herzog 2017a). These intuitions have clear affinities with the justice-based
arguments outlined above.

4.1.3 Speculation and gambling

A sweeping criticism of a more contemporary nature concerns the supposed moral
defects of speculation. This criticism tends to be directed towards financial activities
that go beyond mere lending. Critics of the capitalist system often liken the stock
market to a casino and investors to gamblers or punters (Sinn 2010, Strange 1986).
More moderate critics insist on a strict distinction between investors or shareholders, on
the one hand, and speculators or gamblers, on the other (Bogle 2012, Sorell & Hendry
1994). In any case, the underlying assumption is that the similarities between modern
financial activities and gambling are morally troublesome.

On some interpretations, these concerns are similar to those raised above. For example,
some argue that speculators are driven by the profit motive whereas investors have a

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genuine concern for the underlying business enterprise (Hendry 2013). Others see
speculation as “parasitic”, that is, to be without productive use, and solely dependent
on luck (Borna & Lowry 1987, Ryan 1902). This latter argument is similar to the
complaint about undeserved income raised in particular by Islamic scholars (Ayub 2007,
Warde 2010).

A more distinct interpretation holds that speculation typically includes very high levels
of risk-taking (Borna & Lowry 1987). This is morally problematic when the risks not
only affect the gambler him or herself but also society as a whole. A root cause of the
financial crisis of 2008 was widespread speculation on very risky derivatives such as
“synthetic collateralized debt obligations” (see section 1.2). When the value of such
derivatives fell dramatically, the financial system as a whole came to the brink of
collapse. We will return to this issue below (in section 4.3.1).

A related interpretation concerns the supposed short-sightedness of speculation. It is

often argued that financial agents and markets are “myopic” in the sense that they care
only about profits in the very near term, e.g., the next quarter (Dallas 2012). Modern
disclosure requirements force companies to publish quarterly earnings reports. The
myopia of finance is typically blamed for negative effects such as market volatility, the
continuous occurrence of manias and crashes, inadequate investment in social welfare,
and the general shortsightedness of the economy (e.g., Lacke 1996).

Defenders of speculation argue that it can serve a number of positive ends. To the
extent that all financial activities are speculative in some sense, of course, the ends
coincide with the function of finance more generally: to channel funds to the individuals
or companies who can use them in the most productive ways. But even speculation in
the narrower sense—of high-risk, short-term bets—can have a positive role to play: It
can be used to “hedge” or off-set the risks of more long-term investments, and it
contributes to sustaining “market liquidity” (that is, as a means for providing
counterparties to trade with at any given point of time) which is important for an
efficient pricing mechanism (Angel & McCabe 2009, Koslowski 2009).

4.2 Fairness in Financial Markets

Let us now assume that the existence of financial markets is at least in general terms
ethically acceptable, so that we can turn to discuss some of the issues involved in
making them fair and just for all parties involve. We will focus on three such issues:
deception and fraud (honesty), conflicts of interest (care for customers), and insider
trading (fair play).

4.2.1 Deception and fraud

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Some of the best-known ethical scandals in finance are cases of deception or fraud.
Enron, a huge US corporation, went bankrupt after it was discovered that its top
managers had “cooked the books”, i.e., engaged in fraudulent accounting practices,
keeping huge debts off the company’s balance sheet in an effort to make it look more
profitable (McLean & Elkind 2003). Other scandals in the industry have involved
deceptive marketing practices, hidden fees or costs, undisclosed or misrepresented
financial risks, and outright Ponzi schemes (see section 2).

While these examples seem obvious, on further examination it is not easy to give an
exact definition of financial deception or fraud. The most straightforward case seems to
be deliberately misrepresenting or lying about financial facts. However, this assumes
that there is such a thing as a financial fact, i.e., a correct way of representing a
financial value or transaction. In light of the socially constructed nature of money and
finance (see section 1), this may not always be clear. Less straightforward cases
include simply concealing or omitting financial information, or refraining from obtaining
the information in the first place.

A philosophical conception of fraud, inspired by Kant, defines it as denying to the

weaker party in a financial transaction (such as a consumer or investor) information
that is necessary to make a rational (or autonomous) decision (Boatright 2014, Duska
& Clarke 2002). Many countries require that the seller of a financial product (such a
company issuing shares) must disclose all information that is “material” to the product.
It is an interesting question whether this suggestion, especially the conception of
rationality involved, should include or rule out a consideration of the ethical nature of
the product (such as the ethical nature of the company’s operations) (Lydenberg 2014).
Furthermore, there may be information that is legitimately excluded by other
considerations, such as the privacy of individuals or companies commonly protected by
“bank secrecy” laws.

But is access to adequate information enough? A complication here is that the weaker
party, especially ordinary consumers, may have trouble processing the information
sufficiently well to identify cases of fraud. This is a structural problem in finance that
has no easy fix, because financial products are often abstract, complex, and difficult to
price. Therefore, full autonomy of agents may not only require access to adequate
information, but also access to sufficient know how, processing ability and resources to
analyze the information (Boatright 2014). One solution is to require that the financial
services industry promotes transparent communication in which they track the
understanding of ordinary consumers (de Bruin 2014b, Shiller 2012).

4.2.2 Avoiding conflicts of interest

Due to the problems just noted, the majority of ordinary consumers refrain from
engaging in financial markets on their own and instead rely on the services of financial

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intermediaries, such as banks, investment funds, and insurance companies. But this
opens up new ethical problems that are due to the conflicts of interest inherent in
financial intermediation. Simply put, the managers or employees of intermediaries have
ample opportunity, and often also incentives, to misuse their customers’ money and
trust.

Although it is once again difficult to give an exact definition, the literature is full of
examples of such misuse—including so-called churning (trading excessively to generate
high fees), stuffing (selling the bank’s undesired assets to a client), front-running
(buying an asset for the bank first and then reselling it to the client at a higher price)
and tailgating (mimicking a client’s trade to piggyback on his/her information) (Dilworth
1994; Heacock, Hill, & Anderson 1987). Interestingly, some argue that the whole
industry of actively managed investment funds may be seen as a form of fraud.
According to economic theory, namely, it is impossible to beat the average returns of
the market for any given level of financial risk, at least in the long term. Therefore,
funds who claim that they can do this for a fee are basically cheating their clients (cf.
Hendry 2013, Kay 2015).

A legal doctrine that aims to protect clients is so-called fiduciary duty, which imposes
obligations on fiduciaries (those entrusted with others’ money) to act in the sole
interest of beneficiaries (those who own the money). The interests referred to are
typically taken to be financial interests, so the obligation of the fiduciary is basically to
maximize investment returns. But some argue that there are cases in which
beneficiaries’ broader interests should take precedence, such as when investing in fossil
fuels may give high financial returns but pose serious risks to people’s future
(Lydenberg 2014; Sandberg 2013, 2016). In any case, it is often thought that fiduciary
duties go beyond the ideal of a free market to instead give stronger protection to the
weaker party of a fragile relationship.

As an alternative or compliment to fiduciary duty, some argue for the adoption of a

code of ethics or professional conduct by financial professionals. A code of ethics would
be less arduous in legal terms and is therefore more attractive to free market
proponents (Koslowski 2009). It can also cover other fragile relationships (including
those of bank-depositor, advisor-client, etc.). Just as doctors and lawyers have a
professional code, then, so finance professionals could have one that stresses values
such as honesty, due care and accuracy (de Bruin 2016, Graafland & Ven 2011). But
according to critics, the financial industry is simply too subdivided into different roles
and competencies to have a uniform code of ethics (Ragatz & Duska 2010). It is also
unclear whether finance can be regarded as a profession in the traditional sense, which
typically requires a body of specialized knowledge, high degrees of organization and
self-regulation, and a commitment to public service (Boatright 2014, Herzog
forthcoming).

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4.2.3 Insider trading
Probably the most well-known ethical problem concerning fairness in finance, and also
perhaps the one on which philosophers most disagree, is so-called insider trading. Put
simply, this occurs when an agent uses his or her position within, or privileged
information about, a company to buy or sell its shares (or other related financial assets)
at favorable times and prices. For example, a CEO may buy shares in his or her
company just before it announces a major increase in earnings that will boost the share
price. While there is no fraud or breach of fiduciary duty, the agent seems to be
exploiting an asymmetry of information.

Just as in the cases above, it is difficult to give an exact definition of insider trading,
and the scope of its operative definition tends to vary across jurisdictions. Most
commentators agree that it is the information and its attendant informational
asymmetry that counts and, thus, the “insider” need not be inside the company at all—
those abusing access to information could be family, friends or other tippees (Irvine
1987a, Moore 1990). Indeed, some argue that even stock analysts or journalists can be
regarded as insiders if they trade on information that they have gathered themselves
but not yet made publicly available. It is also debatable whether an actual trade has to
take place or whether insider trading can consist in an omission to trade based on
inside information, or also in enabling others to trade or not trade (Koslowski 2009).

Several philosophical perspectives have been used to explain what (if anything) is
wrong with insider trading. A first perspective invokes the concept of fair play. Even in a
situation with fully autonomous traders, the argument goes, market transactions are
not fair if one party has access to information that the other has not. Fair play requires
a “level playing field”, i.e., that no participant starts from an unfairly advantaged
position (Werhane 1989, 1991). However, critics argue that this perspective imposes
excessive demands of informational equality. There are many asymmetries of
information in the market that are seemingly unproblematic, e.g., that an antiquary
knows more about antiques than his or her customers (Lawson 1988, Machan 1996).
So might it be the inaccessibility of inside information that is problematic? But against
this, one could argue that, in principle, outsiders have the possibility to become insiders
and thus to obtain the exact same information (Lawson 1988, Moore 1990).

A second perspective views insider trading as a breach of duty, not towards the
counterparty in the trade but towards the source of the information. US legislation
treats inside information as the property of the underlying company and, thus, insider
trading is essentially a form of theft of corporate property (often called the
misappropriation theory) (Lawson 1988). A related suggestion is that it can be seen as
a violation of the fiduciary duty that insiders have towards the company for which they
work (Moore 1990). However, critics argue that the misappropriation theory
misrepresents the relationship between companies and insiders. On the one hand, there
are many normal business situations in which insiders are permitted or even expected

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to spread inside information to outside sources (Boatright 2014). On the other hand, if
the information is the property of the company, why do we not allow it to be “sold” to
insiders as a form of remuneration? (Engelen & van Liedekerke 2010, Manne 1966)

A third perspective deals with the effects, both direct and indirect, of allowing insider
trading. Interestingly, many argue that the direct effects of such a policy might be
positive. As noted above, one of the main purposes of financial markets is to form (or
“discover”) prices that reflect all available information about a company. Since insider
trading contributes important information, it is likely to improve the process of price
discovery (Manne 1966). Indeed, the same reasoning suggests that insider trading
actually helps the counterparty in the trade to get a better price (since the insider’s
activity is likely to move the price in the “right” direction) so it is a victimless crime
(Engelen & Liedekerke 2010). However, others express concern over the indirect effects,
which are likely to be more negative. Allowing insider trading may erode the moral
standards of market participants by favoring opportunism over fair play (Werhane
1989). Moreover, many people may be dissuaded from even participating in the market
since they feel that it is “rigged” to their disadvantage (Strudler 2009).

4.3 The Social Responsibility of Finance

We will now move on to take a societal view on finance, and discuss ideas relating to
the broader social responsibilities of financial agents, that go beyond their basic role as
market participants. We will discuss three such ideas here, respectively focusing on
systemic risk (a responsibility to avoid societal harm), microfinance (a responsibility
towards the poor or unbanked), and socially responsible investment (a responsibility to
help address societal challenges).

4.3.1 Systemic risk and financial crises

One root cause of the financial crisis of 2008 was the very high levels of risk-taking of
many banks and other financial agents. When these risks materialized, the financial
system came to the brink of collapse. Many banks lost so much money that their
normal lending operations were hampered, which in turn had negative effects on the
real economy, with the result that millions of “ordinary” people around the world lost
their jobs. Many governments stepped in to bail out the banks and in consequence
sacrificed other parts of public spending. This is a prime example of how certain
financial activities, when run amok, can have devastating effects on third parties and
society in general.
Much subsequent debate has focused on so-called systemic risk, that is, the risk of
failures across several agents which impairs the functioning of the financial system as
such (Brunnermeier & Oehmke 2013, Smaga 2014). The concept of systemic risk gives
rise to several prominent ethical issues. To what extent do financial agents have a
moral duty to limit their contributions to systemic risk? It could be argued that financial
transactions always carry risk and that this is “part of the game”. But the important

BUSFIN 38
point about systemic risk is that financial crises have negative effects on third parties
(so-called externalities). This constitutes a prima facie case for a duty of precaution on
the part of financial agents, based on the social responsibility to avoid causing
unnecessary harm (James 2017, Linarelli 2017). In cases where precaution is
impossible, one could add a related duty of rectification or compensation to the victims
of the harm (James 2017). It is, however, a matter of philosophical dispute whether
finance professionals can be held morally responsible for these harms (de Bruin 2018).

Two factors determine how much an agent’s activity contributes to systemic risk
(Brunnermeier & Oehmke 2013, Smaga 2014). The first is financial risk of the agent’s
activity in the traditional sense, i.e., the probability and size of the potential losses for
that particular agent. A duty of precaution may here be taken to imply, e.g., stricter
requirements on capital and liquidity reserves (roughly, the money that the agents
must keep in their coffers for emergency situations) (Admati & Hellwig 2013). The
second factor is the agent’s place in the financial system, which typically is measured
by its interconnectedness with—and thereby potential for cascading effects upon—other
agents. This factor indicates that the duty of precaution is stronger for financial agents
that are “systemically important” or, as the saying goes, “too-big-to-fail” institutions
(Stiglitz 2009).

As an alternative to the reasoning above, one may argue that the duty of precaution is
more properly located on the collective, i.e., political level (James 2012, 2017). We
return to this suggestion below (in section 5.1).

4.3.2 Microfinance
Even in normal times, people with very low income or wealth have hardly any access to
basic financial services. Commercial banks have little to gain from offering such
services to them; there is an elevated risk of loan losses (since the poor lack collateral)
and it is costly to administer a large amount of very small loans (Armendáriz & Morduch
2010). Moreover, there will likely be cases where some bank officers discriminate
against underprivileged groups, even where extensive legal protection is in place. An
initiative that seeks to remedy these problems is “microfinance”, that is, the extension
of financial services, such as lending and saving, to poor people who are otherwise
“unbanked”. The initiative started in some of the poorest countries of the world, such as
Bangladesh and India.

The justifications offered for microfinance are similar to the justifications offered for
development aid. A popular justification holds that affluent people have a duty of
assistance towards the poor, and microfinance is thought to be a particularly efficient
way to alleviate poverty (Yunus 1998, 2007). But is this correct? Judging from the
growing number of empirical “impact studies”, it seems more correct to say that
microfinance is sometimes helpful, but at other times can be either ineffective or have

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negative side-effects (Hudon & Sandberg 2013, Roodman 2012). Another justification
holds that there is a basic human right to subsistence, and that this includes a right to
savings and credit (Hudon 2009, Meyer 2018). But critics argue that the framework of
human rights is not a good fit for financial services that come with both benefits and
challenges (Gershman & Morduch 2015, Sorell 2015).

Microfinance is of course different from development aid in that it involves commercial

banking relations. This invites the familiar political debate of state- versus market-
based support. Proponents of microfinance argue that traditional state-led development
projects have been too rigid and corrupt, whereas market-based initiatives are more
flexible and help people to help themselves (Armendáriz & Morduch 2010, Yunus 2007).
According to critics, however, it is the other way around: Markets will tend to breed
greed and inequality, whereas real development is created by large-scale investments
in education and infrastructure (Bateman 2010, H. Weber 2004).

In recent years, the microfinance industry has witnessed several “ethical scandals” that
seemingly testify to the risk of market excesses. Reports have indicated that interest
rates on microloans average at 20–30% per annum, and can sometimes be in excess of
100%, which is much higher than the rates for non-poor borrowers. This raises
questions about usury (Hudon & Ashta 2013; Rosenberg, Gonzalez, & Narain 2009).
However, some suggest a defense of “second best”, or last resort, when other sources
of aid or cheaper credit are unavailable (Sandberg 2012). Microfinance institutions have
also been accused of using coercive lending techniques and forceful loan recovery
practices (Dichter & Harper (eds) 2007; Priyadarshee & Ghalib 2012). This raises
questions about the ethical justifiability of commercial activity directed at the
desperately poor, because very poor customers may have no viable alternative to
accepting deals that are both unfair and exploitative (Arnold & Valentin 2013, Hudon &
Sandberg 2013).

4.3.3 Socially responsible investment

Socially responsible investment refers to the emerging practice whereby financial
agents give weight to putatively ethical, social or environmental considerations in
investment decisions—e.g., decisions about what bonds or stocks to buy or sell, or how
to engage with the companies in one’s portfolio. This is sometimes part of a strictly
profit-driven investment philosophy, based on the assumption that companies with
superior social performance also have superior financial performance (Richardson &
Cragg 2010). But more commonly, it is perceived as an alternative to mainstream
investment. The background argument here is that market pricing mechanisms, and
financial markets in particular, seem to be unable to promote sufficient levels of social
and environmental responsibility in firms. Even though there is widespread social
agreement on the evils of sweatshop labor and environmental degradation, for instance,
mainstream investors are still financing enterprises that sustain such unjustifiable

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practices. Therefore, there is a need for a new kind of investor with a stronger sense of
social responsibility (Sandberg 2008, Cowton & Sandberg 2012).

The simplest and most common approach among these alternative investors is to avoid
investments in companies that are perceived to be ethically problematic. This is
typically justified from a deontological idea to the effect that it is wrong to invest in
someone else’s wrongdoing (Irvine 1987b, Langtry 2002, Larmer 1997). There are at
least three interpretations of such moral “taint”: (1) the view that it is wrong in itself to
profit from others’ wrongdoings, or to benefit from other people’s suffering; (2) the
view that it is wrong to harm others, or also to facilitate harm to other; or (3) the view
that there is a form of expressive or symbolic wrongdoing involved in “morally
supporting” or “accepting” wrongful activities.

The deontological perspective above has been criticized for being too black-and-white.
On the one hand, it seems difficult to find any investment opportunity that is
completely “pure” or devoid of possible moral taint (Kolers 2001). On the other hand,
the relationship between the investor and the investee is not as direct as one may think.
To the extent that investors buy and sell shares on the stock market, they are not
engaging with the underlying companies but rather with other investors. The only way
in which such transactions could benefit the companies would be through movements in
the share price (which determines the companies’ so-called cost of capital), but it is
extremely unlikely that a group of ethical investors can significantly affect that price.
After all, the raison d’être of stock exchanges is exactly to create markets that are
sufficiently liquid to maintain stable prices (Haigh & Hazelton 2004, Hudson 2005). In
response to this, the deontologist could appeal to some notion of universalizability or
collective responsibility: perhaps the right question to ask is not “what happens if I do
this?” but instead “what happens if we all do this?”. However, such more complicated
philosophical positions have problems of their own (see also rule consequentialism and
collective responsibility)

A rival perspective on socially responsible investment is the (more straightforward)

consequentialist idea that investors’ duty towards society consists in using their
financial powers to promote positive societal goods, such as social justice and
environmental sustainability. This perspective is typically taken to prefer more
progressive investment practices, such as pushing management to adopt more
ambitious social policies and/or seeking out environmentally friendly technology firms
(Mackenzie 1997, Sandberg 2008). Of course, the flip side of such practices, which may
explain why they are less common in the market, is that they invite greater financial
risks (Sandberg 2011). It remains an open question whether socially responsible
investment will grow enough in size to make financial markets a force for societal
change.

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5. Political Philosophy
Discussions about the social responsibility of finance are obviously premised on the
observation that the financial system forms a central infrastructure of modern
economies and societies. As we noted at the outset, it is important to see that the
system contains both private elements (such as commercial banks, insurance
companies, and investment funds) and public elements (such as central banks and
regulatory bodies). However, issues concerning the proper balance between these
elements, especially the proper role and reach of the state, are perennially recurrent in
both popular and philosophical debates.

The financial system and the provision of money indeed raise a number of questions
that connect it to the “big questions” of political philosophy: including questions of
democracy, justice, and legitimacy, at both the national and global levels. The
discussions around finance in political philosophy can be grouped under three broad
areas: financialization and democracy; finance, money and domestic justice; and
finance and global justice. We consider these now in turn.

5.1 Financialization and Democracy

Many of the questions political philosophy raises about finance have to do with
“financialization”. The phenomenon of “financialization”, whereby the economic system
has become characterized by the increasing dominance of finance capital and by
systems of financial intermediation (Ertürk et al. 2008; Davis 2011; Engelen et al. 2011;
Palley 2013), is of potentially substantial normative significance in a number of regards.
A related normative concern is the potential growth in political power of the financial
sector, which may be seen as a threat to democratic politics.

These worries are, in effect, an amplification of familiar concerns about the “structural
power” or “structural constraints” of capital, whereby capitalist investors are able to
reduce the freedom of action of democratic governments by threatening “investment
strikes” when their preferred political options are not pursued (see Lindblom 1977,
1982; Przeworski & Wallerstein 1988; Cohen 1989; B. Barry 2002; Christiano 2010,
2012). To take one recent version of these worries, Stuart White argues that a
republican commitment to popular sovereignty is in significant tension with the
acceptance of an economic system where important choices about investment, and
hence the direction of development of the economy, are under the control of financial
interests (White 2011).

In many such debates, the fault-line seems to be the traditional one between those who
favor social coordination by free markets, and hence strict limitations on state activities,
and those who favor democratic politics, and hence strict limitations on markets
(without denying that there can be intermediate positions). But the current financial

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system is not a pure creature of the free market. In the financial system that we
currently see, the principle that individuals are to be held financially accountable for
their actions, and that they will therefore be “disciplined” by markets, is patchy at best.
One major issue, discussed above, is the problem of banks that are so large and
interconnected that their failure would risk taking down the whole financial system—
hence, they can anticipate that they will be bailed out by tax-payers’ money, which
creates a huge “moral hazard” problem (e.g., Pistor 2013, 2017). In addition, current
legal systems find it difficult to impose accountability for complex processes of divided
labor, which is why there were very few legal remedies after the financial crisis of 2008
(e.g., Reiff 2017).

The lack of accountability intensifies worries about the power relations between
democratic politicians and individuals or corporations in the financial realm. One
question is whether we can even apply our standard concept of democracy to societies
that have the kinds of financial systems we see today. We may ask whether societies
that are highly financialized can ever be true democracies, or whether they are more
likely to be “post-democracies” (Crouch 2004). For example, states with high levels of
sovereign debt will need to consider the reaction of financial markets in every
significant policy decision (see, e.g., Streeck 2013 [2014]) Moreover “revolving doors”
between private financial institutions and supervising authorities impact on the ability of
public officials to hold financial agents accountable. This is similar to the problems of
conflicts of interest raised above (see sections 2 and 4.2.2). If financial contracts
become a central, or maybe even the most central, form of social relations (Lazzarato
2012), this may create an incompatibility with the equal standing of citizens,
irrespective of financial position, that is the basis of a democratic society.

While finance has, over long stretches of history, been rather strictly regulated, there
has been a reversed trend towards reregulation since roughly the 1970s. After the
financial crisis of 2008, there have been many calls for reregulation. Proposals include
higher capital ratios in banks (Admati & Hellwig 2013), a return to the separation of
commercial banking from speculative finance, as had been the case, in the US, during
the period when the Glass-Steagall Act was in place (Kay 2015), or a financial
transaction tax (Wollner 2014). However, given that the financial system is a global
system, one controversial question is whether regulatory steps by single countries
would have any effect other than capital flight.

5.2 Finance, Money, and Domestic Justice

When it comes to domestic social justice, the central question relating to the finance
system concerns the ways in which the realization of justice can be helped or hindered
by how the financial system is organized.

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A first question here, already touched upon in the discussion about microfinance above
(section 4.3.2), concerns the status of citizens as participants in financial markets.
Should they all have a right to certain financial services such as a bank account or
certain forms of loans, because credit should be seen as a primary good in capitalist
economies (see, e.g., Hudon 2009, Sorell 2015, Meyer 2018)? This is not only an issue
for very poor countries, but also for richer countries with high economic inequality,
where it becomes a question of domestic justice. In some countries all residents have
the right to open a basic bank account (see bank accounts in the EU in Other Internet
Resources). For others this is not the case. It has been argued that not having access
to basic financial services creates an unfairness, because it drives poorer individuals
into a cash economy in which they are more vulnerable to exploitative lenders, and in
which it is more difficult to build up savings (e.g., Baradaran 2015). Hence, it has been
suggested either to regulate banking services for individuals more strictly (e.g., Herzog
2017a), to consider various forms of household debt relief (Persad 2018), or to offer a
public banking service, e.g., run by the postal office, which offers basic services at
affordable costs (Baradaran 2015).

Secondly, financialization may also have more direct effects on socio-economic

inequality. Those with managerial positions within the financial sector are
disproportionately represented among the very top end of the income distribution, and
so the growth of inequality can in part be explained by the growth in the financial sector
itself (Piketty 2014). There may also be an effect on social norms, whereby the
“hypermeritocratic” norms of the financial sector have played a part in increasing social
tolerance for inequality in society more broadly (Piketty 2014: 265; see also O’Neill
2017). As Dietsch et al. point out, the process of increasing financialization within the
economies of the advanced industrial societies has been encouraged by the actions of
central banks over recent decades, and so the issue of financialization also connects
closely to questions regarding the justice and legitimacy of central banks and monetary
policy (Dietsch, Claveau, & Fontan 2018; see also Jacobs & King 2016).

Thirdly, many debates about the relation between distributive justice and the financial
system revolve around the market for mortgages, because for many individuals, a
house is the single largest item for which they need to take out a loan, and their
mortgage their main point of interaction with the financial system. This means that the
question of who has access to mortgage loans and at what price can have a major
impact on the overall distribution of income and wealth. In addition, it has an impact on
how financial risks are distributed in society. Highly indebted individuals are more
vulnerable when it comes to ups and downs either in their personal lives (e.g., illness,
loss of job, divorce) or in the economy as a whole (e.g., economic slumps) (Mian & Sufi
2014). The danger here is that existing inequalities—which many theories of justice
would describe as unjust—are reinforced even further (Herzog 2017a).

Here, however, a question about the institutional division of labor arises: which goals of
distributive justice should be achieved within markets—and specifically, within financial

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markets—and which ones by other means, for example through taxation and
redistribution? The latter has been the standard approach used by many welfare
systems: the idea being to let markets run their course, and then to achieve the desired
patterns of distribution by taxation and redistribution. If one remains within that
paradigm, questions arise about whether the financial sector should be taxed more
highly. In contrast, the approach of “pre-distribution” (Hacker 2011, O’Neill &
Williamson 2012), or what Dietsch calls “process redistribution” (2010), is to design the
rules of the economic game such that they contribute to bringing about the distributive
pattern that is seen as just. This could, for example, mean regulating banking services
and credit markets in ways that reduce inequality, for example by imposing regulations
on payday lenders and banks, so that poor individuals are protected from falling into a
spiral of ever higher debt. A more radical view could be to see the financial problems
faced by such individuals as being caused by more general structural injustices the
solution of which does not necessarily require interventions with the financial industry,
but rather more general redistributive (or predistributive) policies.

Money creation: Another alternative theoretical approach is to integrate distributive

concerns into monetary policy, i.e., when it comes to the creation of money. So far,
central banks have focused on the stability of currencies and, in some cases, levels of
employment. This technical focus, together with the risk that politicians might abuse
monetary policy to try to boost the economy before elections, have been used in
arguments for putting the control of the money supply into the hands of technical
experts, removing monetary policy from democratic politics. But after the financial crisis
of 2008, many central banks have used unconventional measures, such as “quantitative
easing”, which had strongly regressive effects, favoring the owners of stocks or of
landed property (Fontan et al. 2016, Dietsch 2017); they did not take into account
other societal goals, e.g., the financing of green energy, either. This raises new
questions of justice: are such measures justified if their declared aim is to move the
economy out of a slump, which presumably also helps disadvantaged individuals
(Haldane 2014)? Would other measures, for instance “helicopter money” that is
distributed to all citizens, have been a better alternative? And if such measures are
used, is it still appropriate to think of central banks as institutions in which nothing but
technical expertise is required, or should there be some form of accountability to
society? (Fontan, Claveau, & Dietsch 2016; Dietsch 2017; Riles 2018).[2]

We have already discussed the general issue of the ontological status of money (section
1.1 above). But there are also significant questions in political philosophy regarding the
question of where, and by what sorts of institution, should the money supply be
controlled. One complicating factor here is the extensive disagreement about the
institutional basis of money creation, as described above. One strand of the credit
theory of money emphasizes that in today’s world, money creation is a process in which
commercial banks play a significant role. These banks in effect create new money when
they make new loans to individual or business customers (see McLeay, Radia, &
Thomas 2014; see also Palley 1996; Ryan-Collins et al. 2012; Werner 2014a,b). James
Tobin refers to commercial bank-created money, in an evocative if now dated image as

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“fountain pen money”, that is, money created with the swish of the bank manager’s
fountain pen (Tobin 1963).

However, the relationship between private commercial banks and the central bank is a
complicated one, such that we might best think of money creation as a matter involving
a kind of hybrid public-private partnership. Hockett and Omarova refer to this
relationship as constituting a “finance franchise”, with private banks being granted on a
“franchise” basis the money-creating powers of the sovereign monetary authority, while
van ’t Klooster describes this relation between the public and private as constituting a
“hybrid monetary constitution” (Hockett & Omarova 2017; van ’t Klooster 2017; see
also Bell 2001). In this hybrid public-private monetary system, it is true that private
commercial banks create money, but they nevertheless do so in a way that involves
being regulated and subject to the authority of the central bank within each monetary
jurisdiction, with that central bank also acting as “lender of last resort” (Bagehot 1873)
when inter-bank lending dries up.[3]

When the curious public-private nature of money creation is brought into focus, it is not
surprising that there should exist views advocating a shift away from this hybrid
monetary constitution, either in the direction of a fully public option, or a fully private
system of money creation.

Advocates of fully public banking envisage a system in which private banks are stripped
of their authority to create new money, and where instead the money supply is directly
controlled either by the government or by some other state agency; for example by the
central bank lending directly to firms and households. Such a position can be defended
on a number of normative grounds: that a public option would allow for greater
financial stability, that a fully public system of money creation would allow a smoother
transmission of democratic decisions regarding economic governance; or simply
because of the consequences of such a system with regards to socioeconomic inequality
and environmental sustainability (see Jackson & Dyson 2012; Wolf 2014a,b; Lainà 2015;
Dyson, Hodgson, & van Lerven 2016a,b; Ingham, Coutts, & Konzelmann 2016; Dow
2016; for commentary and criticism see Goodhart & Jensen 2015; Fontana & Sawyer
2016).

In stark contrast, a number of libertarian authors have defended the view that the
central bank should have no role in money creation, with the money supply being
entirely a matter for private suppliers (and with the consumers of money able to choose
between different rival suppliers), under a system of “free banking” (e.g., Simons 1936;
Friedman 1962; von Hayek 1978; Selgin 1988). Advocacy of private money creation
has received a more recent stimulus with the rise of Bitcoin and other crypto-currencies,
with some of Bitcoin’s advocates drawing on similar libertarian arguments to those
offered by Hayek and Selgin (see Golumbia 2016).

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5.3 Finance and Global Justice
Finally, a number of issues relate questions about finance to questions about global
justice. The debate about global justice (see also global justice) has weighed the pros
and cons of “statist” and “cosmopolitan” approaches, that is, approaches to justice that
would focus on the nation state (maybe with some additional duties of beneficence to
the globally poor) or on the global scale. The financial system is one of the most
globalized systems of social interaction that currently exist, and global entanglements
are hard to deny (e.g., Valentini 2011: 195–8). The question thus is whether this
creates duties of justice on the financial system, and if so, whether it fulfills these
duties, i.e., whether it contributes to making the world more globally just, or whether it
tends in the opposite direction (or whether it is neutral).

There are a number of institutions, especially the World Bank and the International
Monetary Fund (IMF), that constitute a rudimentary global order of finance. Arguably,
many countries, especially poorer ones, cannot reasonably opt out of the rules
established by these institutions (e.g., Hassoun 2012, Krishnamurthy 2014). It might
therefore appear to be required by justice that these institutions be governed in a way
that represents the interests of all countries. But because of historical path-
dependencies, and because a large part of their budget comes from Western countries,
the governance structures are strongly biased in their favor (for example, the US can
veto all important decisions in the IMF). Miller (2010: 134–41) has described this
situation as “indirect financial rule” by the US.

An issue worth noting in this context is the fact that the US dollar, and to a lesser
degree the Euro, function as de facto global currencies, with a large part of global trade
being conducted in these currencies (e.g., Mehrling 2011, Eichengreen 2011). This
allows the issuing countries to run a current account deficit, which amounts to a
redistribution from poorer to richer countries for which compensation might be owed
(Reddy 2005: 224–5). This fact also raises questions about the distribution of power in
the global sphere, which has often been criticized as favoring Western countries (e.g.,
Gulati 1980, United Nations 2009). However, global financial markets serve not only to
finance trade in goods and services; there are also questions about fluctuations in these
markets that result exclusively from speculations (see also sect.1.4.3 above). Such
fluctuations can disproportionately harm poorer countries, which are more vulnerable to
movements of capital or rapid changes in commodity prices. Hence, an old proposal
that has recently been revived and defended from a perspective of global justice is that
of a “Tobin tax” (Tobin 1978), which would tax financial transactions and thereby
reduce volatility in international financial markets (Reddy 2005, Wollner 2014).

A second feature of the current global order that has been criticized from a perspective
of justice is the “borrowing privilege”. As Pogge describes (e.g., 2008: chap. 4), the

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governments of countries can borrow on international financial markets, no matter
whether they have democratic legitimacy or not. This means that rogue governments
can finance themselves by incurring debts that future generations of citizens will have
to repay.

Sovereign debt raises a number of questions that are related to global justice. Usually,
the contracts on which they are based are considered as absolutely binding (e.g., Suttle
2016), which can threaten national sovereignty (Dietsch 2011). This holds in particular
with regard to what has been called “odious” debt (Sack 1927, Howse 2007, Dimitriu
2015, King 2016): cases in which government officials sign debt contracts in order to
enrich themselves, with lenders being aware of this fact. Such cases have been at the
center of calls for a jubilee for indebted nations. At the moment, there are no binding
international rules for how to deal with sovereign bankruptcy, and countries in financial
distress have no systematic possibility of making their claims heard, which is
problematic from a perspective of justice (e.g., Palley 2003; Reddy 2005: 26–33;
Herman 2007; C. Barry & Tomitova 2007; Wollner 2018). The IMF, which often
supports countries in restructuring sovereign debt, has often made this support
conditional upon certain requirements about rearranging the economic structures of a
country (for a discussion of the permissibility of such practices see C. Barry 2011).

Finally, and perhaps most importantly, the issue of financial regulation has a global
dimension in the sense that capital is mobile across national boundaries, creating the
threats to democracy described above. This fact makes it difficult for individual
countries, especially smaller ones, to install the more rigid financial regulations that
would be required from a perspective of justice. Just as with many other questions of
global justice (see, e.g., Dietsch 2015 on taxation), we seem to see a failure of
coordination between countries, which leads to a “race to the bottom”. Making global
financial institutions more just is therefore likely to require significant levels of
international cooperation.

Bibliography
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71(1): 173–204. doi:10.1111/1468-0262.00393
Admati, Anat and Martin Hellwig, 2013, The Bankers’ New Clothes. What’s Wrong with
Banking and What to Do about It, Princeton, NJ: Princeton University Press.
Angel, James J. and Douglas M. McCabe, 2009, “The Ethics of Speculation”, Journal of
Business Ethics, 90(supp. 3): 277–286. doi:10.1007/s10551-010-0421-5
Aquinas, Summa Theologica, Fathers of the English Dominican Province, trans. 5 vols.
Westminster, MD: Christian Classics, 1981.

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