U.S. banks, regulators see progress, but not yet victory, in culture battle

May 17, 2016

The struggle to instill stronger cultural values and ethics into U.S. banking organizations has shown signs of progress over the recent past, but maintaining momentum requires business leaders to remain committed to the process, according to senior bankers and regulators. Moreover, it remains to be seen whether the reforms banks have put in place prevent any future scandals from emerging.

At a conference sponsored by Thomson Reuters this week on bank cultural reform, the common view was that banks, particularly the largest U.S. firms, had made progress in reforming their cultures, this coming after New York Federal Reserve Bank president William Dudley had warned the industry two years ago that cultural and ethical change was imperative.

“Yes I see progress,” said Thomas Baxter, executive vice president and general counsel of the New York Fed. “I think that we’ve come quite a distance in two years.”

In particular, Baxter cited progress in terms of disciplining bankers who stray from an institution’s cultural norms. “We’ve made real progress with respect to discipline over those who depart from an organization cultural norms . . . and so I look at that as a measure of success,” he added.

However, with respect to conduct, Baxter said progress was less noticeable.

“With respect to conduct I don’t think we are seeing the results that I was hoping for, yet. And I think that’s a function of the fact of how long it takes to effect a cultural change in not only a single organization, but also how long it takes to effect cultural change in the industry,” he said.

Self-identification of problems

One of the more noticeable developments from a regulatory perspective was that large banks were becoming more proactive in identifying internal problems with employee behavior, and escalating those issues quickly to senior management.

“What we do see across our institutions are a lot more self-identified issues, where the banks are internally, whether it be the business units, independent risk management or audit, defining and escalating those issues up, and then giving themselves an opportunity to address them before we come in,” said Molly Scherf, deputy comptroller for large banks at the Office of the Comptroller of the Currency.

In addition, from a supervisory aspect, it was important for banks to understand that the regulator was not there to prescribe a specific set of norms or behavior, but rather to understand whether an organization was taking steps to ensure that its own cultural rules and norms were being followed. A central aspect to the development of a cultural program was the involvement of senior management.

“One of the key messages that the OCC has indicated in multiple conversations is that we really do believe that the culture and how the culture is rolled out and maintained in an institution really does belong to senior management,” said Scherf.

“While we might provide a view on things they might be able to do better, we don’t have an official assessment process for whether a cultural program or anything like that is appropriate or not. We focus more on how well have the expected behaviors been articulated, communicated and whether people are following them,” she added.

Business leaders must own culture process

For banks that have gone through what Sally Dewar, managing director at JPMorgan, called the “anger, denial curve” on culture, the critical ingredient in effecting change was senior level engagement. Any program focused on culture needed buy-in from the top and those running various lines of business. The issue could not be left to compliance or human resources.

“Unless the business buy into it you are not going to get the sustainable change that you need,” Dewar told the conference, adding that a conscious decision was made not to have their own culture program be led by compliance or human resources.

Dewar described how the bank implemented a global program in 2015 that included identifying 1,600 so-called “cultural ambassadors” who were seen as employees who upheld the cultural values of the firm. These ambassadors then engaged approximately 16,000 employees worldwide in interviews to discover what JPMorgan’s culture meant to them, what was working, and what was not.

The undertaking led to a series of reforms that were then embedded into the entire “life-cycle” of employees, from their onboarding process to performance evaluations, compensation and any disciplinary actions that were needed.

“The way that we’ve thought about behavior is to look at the life cycle of an employee. From the moment that we have a recruitment campaign to inducting and onboarding that individual to training programs, to setting objectives and performance appraisals, compensation and disciplinary exits,” said Dewar.

But the task maintaining the culture program remains with the business. While compliance and human resources monitor employee behavior for any shortcomings, it is the business that owns the process, a view shared by others.

“What is very, very important is that it is not seen as simply a surveillance, compliance punishment exercise. But rather there is positive reinforcement of good behavior and doing business the right way, led by the business. It is absolutely critical,” said Michael Alix, a principal in the financial regulatory practice of PwC, the consultancy.

Metrics seen useful, but only part of the solution

Several of the panelists pointed to use of metrics to track employee behavior and help identify individuals who might skirting existing compliance rules and requirements. Dewar of JPMorgan, for example, pointed to research at the Financial Conduct Authority in the UK had done that was seen as useful in monitoring employees who might potentially cross the line.

Specifically, employees who did not take routine compliance requirements such as mandatory two-week leave, or trading staff who engaged in excessive cancel-and-correct transactions, breached existing risk limits, or routinely missed compliance training courses, were all seen as predictors of future behavior.

“What we are finding is that a very comprehensive tool is being developed to draw those data points into one place so that you have a view of a trader and their behavior in terms of the way they operate,” said Dewar. “If you take all those data points and put them into a profile, you could at any point in time build up a picture of the compliance culture, if you like, of that individual. What the FCA found was that there is direct correlation between their behavior at the time and the likelihood of them acting inappropriately in the marketplace.”

From his vantage point of having worked with numerous banks in the industry, Alix of PwC said there were now tools available that monitored trader phone conversations to detect levels of stress that might be red flags for compliance staff.

“There are analytic tools being developed to do monitoring not only of the words being used but the emotion and the apparent stress of the person on the phone, to try to filter what is obviously billions of minutes of conversation into and find areas for further investigation,” said Alix.

But both he and Dewar agreed that such technological innovations could only take you so far.

“You can have all of the ‘gotcha tools’ you can create, but you better have the right message, otherwise you’re sensors are going to go off all the time and you’ve got a problem,” added Alix.

Lingering industry obstacles to change

Among the external challenges for banks in making headway on the culture front, some pointed to several obstacles, including the ability for employees who have been dismissed from a firm because of misconduct to find jobs at other institutions who remained unaware of their prior track records.

According to the New York Fed’s Baxter, the fault here rested with laws designed to protect firms against lawsuits from employees who were fired. Baxter cited research which showed a high percentage of “bad actors” being able to move from firm to firm.

“The legal profession, is partially to blame,” said Baxter. “When you think about it, what lawyers are advising the institutions that are sacking these individuals is if you disclose to the successor employer that you fired Mary because she was stealing money from customer accounts, that Mary might have a heck of a libel or intentional infliction of stress claim, so you better not do it.”

“That’s the state of play right now. That’s what’s happening every single day. The successor employer is not getting that information, and that’s a real problem,” he added.

Another area of concern was sub-cultures within large organizations, such as those discovered in the foreign exchange rate fixing scandal. Employees engaged in these trading groups had their own language and culture that transcended the larger corporate entity, and because of legal constraints which made it difficult for banks to document their misconduct when fired, such individuals were able to remain in the industry.

“(This is a) confederation of individuals who know each other well, and are able to move from institution to institution and keep doing business with their brothers and comrades, and this causes some real problems,” said Baxter.

Jury still out on whether reforms will be effective

While banks have made efforts to embed culture and values more explicitly in their organizations, the real test of such reforms will come in the next few years, and whether they are able to avoid the type of behavior seen in high-profile scandals such as Libor and foreign exchange collusion cases.

“I think time will tell whether the cultural reform programs that institutions have put in place manifest themselves in consistent over the long term avoidance of the kinds of problems that have given the industry such reputational trouble,” said Alix of PwC.

“Yes, there has been some progress, but there is still quite a lot of work to do,” he added.

(Henry Engler is a North American Regulatory Intelligence Editor for Thomson Reuters Regulatory Intelligence. He is a former financial industry compliance consultant and executive, and earlier served as a financial journalist with Reuters. Email Henry at henry.engler@thomsonreuters.com)

(This article was produced by Thomson Reuters Regulatory Intelligence and initially posted on May. 6. 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: @thomsonreuters)

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