Bank reform or bust

Despite improving levels of credit losses, return on equity in banks since the crisis has been held between 5 per cent and 7 per cent, below the cost of capital.

The operating cost base of banks has on the other hand increased steadily with conduct-related fines, client litigation and redress accounting for some 7.5 per cent of running costs. Fines and redress for conduct failures averaged 30 per cent of total provisions held by banks against credit losses, which fell by 34 per cent in the same period. This has undermined banks’ performance and valuations significantly with the average bank’s price-to-book ratio standing at just below 1. Market confidence is clearly still very fragile, fuelled by the severity of conduct issues.

The Edelman Trust Barometer which asks participants to assess how much they would trust businesses in each industry “to do what is right” reported dramatic falls in consumer trust across all industries immediately after the crisis. At 21 per cent, the banking sector experienced the biggest drop by far and while most have recovered, this sector has remained some 30 per cent below its pre-crisis level.

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Continued stockpiling of capital buffers is, however, not the answer, as the regulators have acknowledged. Instead, trust in the valuation of the banking sector requires restoring confidence in those charged with leading and entrenching an appropriate risk culture that is able to strike the right balance between consumer outcomes and stakeholder interests.This risk culture drum has been sounded by nearly every post-crisis analysis, the latest being the report by the Group of Thirty (G30) forum of international leaders, titled Banking Conduct and Culture: A Call for Sustained and Comprehensive Reform, which is a culmination of several years’ study of governance challenges in banks since 2009.


Unlike past studies, this report feels different. It considers resolute actions across policymakers, regulatory supervisors and boards of banks alike. It recognises poignantly that more regulation will neither reverse the negative perceptions nor the performance of banks. In particular, the report invites regulators to “carefully consider the limited effectiveness of promulgating rules on values and conduct” on the basis that culture is about behaviours “which are not amenable to legislation or regulation”.

The conduct reforms it calls for are more profound. They cannot be ephemeral but must be integrated and sustainable. According to the report, the banking sector cannot afford continued uncertainty over conduct costs which are hampering the fundamental re-evaluation of the sector.

The climb for banks is steep. Defining the model behaviours and desired risk culture for any organisation is not straightforward. It is influenced by a number of factors that include a bank’s strategy and maturity of its risk management. Entrenching and measuring the desired behaviours and culture is even more challenging. The Financial Stability Board offers four key indicators of risk culture: tone from the top, effective challenge, accountability and incentives.

Tone from the top, according to the FSB, involves the directors and senior management of the organisation determining the desired values and risk culture as well as demonstrating behaviours that ‘…reflect the values being espoused’. There is therefore an expectation that the leadership of the organisation ‘should systematically develop, monitor and assess the culture’ of the organisation. The challenge for most leaders is determining what a good assessment of culture looks like and even more crucially how to tackle behaviour change.