Global finance leaders to banks: reform culture and conduct or face more regulation

August 3, 2015

A number of the world’s largest banks are still failing to implement much needed cultural and conduct reforms in their businesses, and a failure to do so could spur more government regulation, a long awaited report by the Group of Thirty (G30) forum of international finance leaders said on Thursday.

The G30 said that efforts had been made to strengthen internal cultures, but many banks still need to implement reforms on compensation and the dismissal of employees – including top executives. In addition, the group argued for new approaches to hiring policies, and stronger roles by boards of directors to ensure cultural and conduct changes. 

The report, the Banking Conduct and Culture: A Call for Sustained and Comprehensive Reform , says failure by banks to implement across-the-board cultural and conduct reforms could lead to still more regulatory rules and actions.

“Piecemeal approaches are not good enough. Aspirational leadership statements by bankers must be matched by effective and disciplined implementation programs,” said Jean-Claude Trichet, chairman of the G30 and former president of the European Central Bank. “Today, we are proposing comprehensive reforms in the approaches to bank culture and conduct that are both essential and urgent.”

Trichet added: “We know that there continue to be investigations of alleged wrong-doing by banks and that the pressures on official authorities to introduce new regulations will rise. Banks need to demonstrate the capacity to reform themselves.”

On the prospect of future regulation should bankers not heed to call for cultural reform, Sir David Walker, vice chairman of the G30 Steering Committee, said at a press conference on Thursday: “I think bankers and regulators alike do not believe that more regulation is the answer to the issues of culture and conduct . . . At the same time, we are aware that there is a probability that further acts of wrong-doing at some institutions will surface.”

“The alternative to action might be more regulation and this could have unintentional damaging consequences for the ability of the banking system to best serve the financial needs of the economy,” Walker added.

The 84-page report on banking culture, based on nearly 80 interviews with industry leaders, central bankers and other officials in 17 countries, highlighted six areas where banks should focus their attention. A summary of these along with specific examples are as follows:

A fundamental shift in the mindset on culture

“If not there already, banks should shift the implementation approach to ‘this problem is core to our business model and fixing it is key to the economic sustainability of the institution,’ raising the bar for CEO and Executive team leadership, visibility, and appetite to consistently take difficult internal sanctioning decisions (ensuring material consequences in terms of both termination of implicated management and employees, and significant compensation adjustments). Sanctioning must affect those with oversight responsibility, including the CEO, for any new issues that arise, and include those who exercise willful blindness,” the report said.

• Banks should look at culture, and achieving consistent behavior and conduct aligned with firm values, as key to strategic success, rather than a separate work stream or add-on process to respond to short-term public, regulatory, or enforcement priorities.

• Banks’ behaviors and conduct should be open to constructive internal challenge. Banks need to have processes that welcome and can deal with self-identification or escalation of issues.

Senior accountability and governance

“Boards should ensure that oversight of embedding values, conduct, and behaviors remains a sustained priority, with the primary responsibility resting with the CEO and Executive team for ensuring that the ‘tone from the top’ has a clear and consistent ‘echo from the bottom.'”

• If the chair and CEO positions are not split, boards should ensure that the lead independent director spends adequate time in the effective challenge role to the CEO on values and conduct issues.

• Boards should ensure that the CEO and executive team are highly visible champions of the desired values and conduct, and that they face material consequences if there are persistent or high-profile conduct and values breaches.

• The CEO should ensure that there is a thorough process that reviews the bank’s brand and reputational standing with the full scope of internal and external stakeholders to recommend any corrective or strengthening initiatives to the executive team.

Performance management and incentives

“Banks should ensure that their performance management does not reward individuals who do not meet a threshold of acceptable behavior in alignment with firm values and conduct expectations. This includes meaningful and consistent compensation adjustments (for example, bonus reduction or elimination, claw backs) in the event of identified failures. This requires use of a meaningful balanced scorecard approach based on objective criteria.”

• Implement individual review and assessment of the top 200 to 400 most senior executives (in Global Systemically Important Financial Institutions (G-SIFIs) or Domestic Systemically Important Financial Institutions (D-SIFIs)) by the senior leadership and CEO. For smaller banks, the number would be smaller, but many more than just executive committee members who report to the CEO.

• Improve compensation and promotion processes to ensure they take account of desired behaviors, including consequences for weak management oversight or willful blindness. The processes should ensure that misconduct and violation of bank culture come at a meaningful price for those responsible for such behavior (for example, reduced compensation, termination, career limitation). Management and all staff should be made aware that unacceptable behavior and transgressions will engender appropriate disciplinary action.

Staff development and promotion

“Banks should continue to establish robust processes to explain and regularly reinforce to staff what is expected of them.”

• Formulate and implement a system-wide values and conduct evaluation process for internal promotions and external hires. These send strong messages about what the bank values in practice.

• Buttress first-line skills and ensure that frontline management and leadership are properly trained in how to conduct judgment-based staff evaluation on desired values and conduct and dealing with identified breaches. Examples from the bank’s own experience (both positive and negative) can be powerful.

• Emphasize diversity (cognitive, gender, racial, background) throughout the bank as a key contributor to improved values and conduct and sustained behavioral change.

An effective three lines of defense

“All employees and all levels of management should adhere to values, conduct, and behavioral expectations. Business line management—the first line of defense—should shoulder primary responsibility for delivering the desired values and conduct, with the second line setting standards, monitoring, and providing advice to the first line. The third line should be robust and mandated to test adherence to the stated standards.”

• Staff and management in the business (the first line of defense) should shoulder the largest responsibility for judging what behavior is or is not in line with the bank’s values and desired conduct. This will be a significant change for how many think of their role and purpose.

• Banks should allocate clear second-line ownership to compliance or risk management functions, and ensure that the designated function is on the executive team. The designated function should seek input from all other relevant functions as necessary (for example, human resources). Remuneration levels in these functions need to be sufficient to attract high-quality individuals who can command the respect of the business. The designated second line needs to develop skill sets and priorities to be better equipped to deal with difficult judgments on values and behaviors and act as a more effective advisor to the first line.

• Banks should challenge the conventional wisdom on legal impediments—that too often lead to “no action” being recommended by internal legal teams—and ensure that robust penalties and appraisal processes are in place. These should include staff or management termination and compensation adjustments. Employers should ensure that full due diligence is completed on past employment history of potential new hires. In addition, authorities may need to consider launching a registry; but there are considerable legal hurdles to achieving this within and across jurisdictions.

Regulators, supervisors, and enforcement authorities

“Addressing cultural issues must of necessity be the responsibility of the board and management of firms. Supervisors and regulators cannot determine culture, but supervisors should have an important monitoring function.”

• Regulators should carefully consider the limited effectiveness of promulgating rules related to values and conduct.

• Conduct-of-business and prudential supervisors can, however, gauge the effectiveness of board and management processes that generate tangible oversight and change in values and conduct. It is possible for supervisors to have enough information to credibly identify serious problems institutions are not addressing. Supervisors should challenge the board and senior executive on how they oversee, understand, measure, and manage the problem. This should allow for early intervention by the supervisor to have the institution rectify serious deficiencies through a variety of informal and formal tools.

• There is a marked difference among authorities in the balance between ex ante supervision and much more heavy use of after-the-fact enforcement and introduction of specific rules. We find that conduct-related prevention, using a range of informal and formal supervisory tools, backed up by robust enforcement, can produce a better outcome for society. To rectify what now amounts to a supervision deficit in some jurisdictions, authorities should ensure that conduct-of-business supervision has sufficient focus on early intervention to prevent issues before these materialize or magnify in severity. Supervisory teams would benefit from an injection of experience and behavioral skill sets to provide more powerful insights and benchmarking evidence to banks. This assessment should be embedded into the core supervisory work, rather than developed as an “add-on” task or objective. In addition, enforcement authorities should review the tilt toward actions against entities rather than individuals, to ensure the desired incentive effects are being achieved.

Mechanisms for achieving cultural transformation

The report also outlined “three critical mechanisms” for achieving the cultural transformation in the banking industry. These include:

• Enforcement of “black letter” (widely accepted) law: there are multiple, complex issues relating to proportionality and accountability of individuals vs. institutions that require careful consideration by enforcement agencies.

• Board- and management-led sustained embedding of substantially improved culture and values, with supervisory monitoring.

• The competitive effect that should—in time—create competitive advantage for firms that have demonstrably better cultures and conduct, with respect to client reputation and the ability to attract and retain skilled staff and attract investors.

(This article was produced by Thomson Reuters Regulatory Intelligence. Regulatory Intelligence provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 400 regulators and exchanges. Follow Regulatory Intelligence compliance news on Twitter: @RiskMgment)

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