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.
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.
Resolute
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.
Effective challenge is according to the FSB a reflection of a sound risk culture in an organisation. This necessitates an environment of open and constructive engagement among employees in order that both positive and critical attitudes are stimulated in decision-making processes.
Accountability refers to a clear understanding of the organisation’s core values and approach to risk, and more importantly, to the awareness of individuals that they will have to account for their risk-taking behaviours. In the G30 study of values in some 46 major banks across the world, we note that accountability featured in less than one-fifth of the banks observed. The new Senior Manager Regime for banks which comes into effect in March 2016 ensures accountability is taken seriously. This new regime will require banks to re-examine their assessment of the maturity of their approach to managing risks across the risk spectrum which includes strategic, financial, operational as well as conduct risks. The failure to manage risks across the spectrum will result in reputation risk, the management of which should lie at the heart of what every responsible bank does.
The FSB have also stressed the importance of supporting incentive policies with financial and non-financial measures that encourage and reinforce the organisation’s desired risk management behaviours.
The crisis taught us that having a correct set of published values or policies for managing every aspect of the business cannot by themselves guard against destructive behaviours. Virtually all financial institutions have shiny mission and value statements as well as ethics and conduct policies. In its analysis of 46 major banks across the world, the G30 study identified that there were seven prominent themes in the values observed. They were trust and integrity, respect and teamwork, excellence, customer service, financial performance, accountability and leadership. Trust and integrity were most frequently used. The intent of these value sets according to the report was to ‘create a strong and effective culture.’
By their nature, value statements contain good intent but are meaningless if they are not enforced or are inconsequential. The real measure of value statements is their impact on the decisions and actions of the organisation.
Review
Take the example of incentives. Following their recent thematic review of firms’ incentives and performance management, the FCA reported in its paper Risks to Customers from Performance Management at Firms, that incentive schemes and policies have improved but tensions remain between reward structures and actual behaviours. Some firms are undermining the use of balanced scorecards by being over focused on sales results which can ultimately lead to pressure selling. PPI mis-selling springs to mind. Bad practice cited by the paper includes an environment where staff feel unable to raise concerns openly, relying instead on confidential whistle-blowing procedures.
In reality, the intended balanced approach in scorecards tends to diminish when performance is under pressure. The G30 report warns of the phenomenon of the ‘blocking middle’ which represents middle management with a tendency to revert to traditional performance measures such as revenue and profits despite the desired conduct and values espoused by the top. This can be attributed to the focus on what is measurable rather than what counts, the latter falling into the more-difficult bucket.
Intent is far easier to state than to act upon. Defining and measuring conduct reform surely must therefore extend beyond intent.
Risk culture assessments that focus mainly on the intent and compliance with the written word will inevitably be superficial. Effective assessment of risk culture will need to get under the skin of the organisation and examine the actions of the organisation in moments of truth. As culture is principally the perception of an organisation’s customers and external stakeholders, it follows that an assessment of culture should involve examining the depth in which customer-centricity is integrated in the way business is done. The FCA also have indicated that they will judge a firm’s success in reforming culture by assessing the customer outcomes over time.
Processes
If there is real intent to reform culture within banks, then more attention should be given to those processes that seek to understand and develop the customer experience; those that aim to listen to customer feedback and their complaints; and those that seek to do the right thing for the customer rather than focus on doing things right from an internal perspective.
Organisations that seek only to cover their interests to superficially meet regulatory requirements are likely to come undone in the longer term, particularly as the regulators strengthen their approach to conduct supervision. With regulators expected to continue to sharpen their regime of credible and dissuasive enforcement, firms that do not ‘fix’ their culture can expect to see fines and sanctions as dramatic as those seen in recent times. Public trust together with returns on equity will remain equally dramatically low.
The economic imperative for banks to review their behaviours and the impact they have on consumers is clear. Conduct reform or bust is a risk warning embedded in the G30 report which we should heed if we truly wish to restore trust and confidence in banks.
Vicky Kubitscheck is a non-executive director at Hampden & Co (Bankers), CRO and compliance director at Police Mutual Group
Key points
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.
Effective challenge is according to the FSB a reflection of a sound risk culture in an organisation.
FCA reported recently that incentive schemes and policies have improved but tensions remain between reward structures and actual behaviours.
