One has been trying to read as much financial history as possible across countries. It is all fascinating to read through accounts of ways things were financed back then and the hardships faced. One also comes across how financial innovations of today were used historically and there is hardly anything modern or innovative about them.
Another thing which emerged is strong cultural and trust values in banking firms. Firms that instilled these values early on and remained committed survived much longer than their peers. Leave all balance sheet analysis and financials aside. It is this cultural aspect which matters as greatly for both survival and growth of a banking firm. This applies to most firms but much more to banks for whom gaining trust and maintaining it is really central to everything.
The crisis of 2008 is leading all these lost values to come back. Regulators stinged by the crisis despite all the fancy financing techniques and Basel norms, now realise culture of a firm is what matters at the end of the day.
In this speech, Andrew Bailey of Bank of England sums up the issues:
There is a reasonable debate about what is culture, but that is not a debate about whether it is important. In my view, culture is a product of a wide range of contributory forces: the stance and effectiveness of management and governance, including that well used phrase “the tone from the top”; the structure of remuneration and the incentives it creates; the quality and effectiveness of risk management; and as important as tone from the top, the willingness of people throughout the organisation to enthusiastically adopt and adhere to that tone. Out of this comes an overall culture. It is not something that has a tangible form. As supervisors, we cannot go into a firm and say “show us your culture”. But we can, and do, tackle firms on all the elements that contribute to defining culture, and from that we build a picture of the culture and its determinants.
Culture has a major influence on the outcomes that matter to us as regulators. My assessment of recent history is that there has not been a case of a major prudential or conduct failing in a firm which did not have among its root causes a failure of culture as manifested in governance, remuneration, risk management or tone from the top. Culture has thus laid the ground for bad outcomes, for instance where management are so convinced of their rightness that they hurtle for the cliff without questioning the direction of travel. We talk often about credit risk, market risk, liquidity risk, conduct risk in it’s several forms. You can add to that, hubris risk, the risk of blinding over-confidence. If I may say so, it is a risk that can be magnified by broader social attitudes. Ten years ago there was considerable reverence towards, and little questioning of, the ability of banks and bankers to make money or of whether boards demonstrated a sufficient diversity of view and outlook to sustain challenge. How things have changed. Healthy scepticism channelled into intelligent and forceful questioning of the self-confident can be a good thing. In turn, culture matters to us as financial regulators because it can, left alone, tend to shape and encourage bad outcomes, but it doesn’t have to do that.
Happy revisiting history.
So what can regulators do and not do?
What can we do therefore as regulators to shape and influence better outcomes on a more consistent basis? Let me start with one thing that we cannot do. As regulators, we are not able, and should not try, to determine the culture of firms. We cannot write a regulatory rule that settles culture. Rather, it is the product of many things, which regulators can influence, but much more directly which firms themselves can shape. We seek to ensure that firms have robust governance, which includes appropriate challenge from all levels of the organisation; and promote the acceptance that not all news can be good and the willingness to act on and respond promptly to bad news. We insist that remuneration is structured to ensure that individuals have skin in the game, namely that a meaningful amount of past remuneration is retained or deferred and for senior people is at risk should problems then emerge. We require that risk management and internal audit in firms are effective and act to root out poor incentives and weak controls. All of this is important and central to what we do as regulators, but let me reinforce the point that culture begins and lives, and I am afraid dies, at home, with firms.
It is not for us as regulators to prescribe culture, that would not work. Firms and their management have to want good culture. But we can have a lot of influence here.
Then he sums up the steps taken by BoE to try and influence culture:
In the last few months we have taken a very important step here by introducing for banks the Senior Managers and Certification Regime, as proposed by the Parliamentary Commission on Banking Standards. It replaces the Approved Persons Regime, and in time it will be implemented across the regulated financial services sector.
There is, let me be clear, no magic bullet to change culture, but the new regime is a big step forward in my view. This is because at its heart it embeds the notion of personal responsibility for the affairs of the firm at the level of senior management. The Approved Persons Regime did not do this, and in practice it focused on a notion of culpability not responsibility. These two notions are different. I have said many times, but will keep doing so, that senior managers cannot delegate responsibility. To be fair, many have said to me over the last few years that this change does not make a difference for them as they always thought they were responsible. Good. But, set this against other conversations I have had which have doubted the enforceability of this notion of responsibility. This has concerned, but not distracted me. So, to be clear, responsibility is the central plank of the new Senior Managers Regime. We do want senior managers to feel this responsibility in all that they do and that includes a responsibility for forming and implementing a positive culture throughout the organisation. In this respect culture is no different to strategy; where are we today, where do we aspire to be tomorrow, how will we get there and what risks must we mitigate along the way.
Responsibility, as embedded in the Senior Managers Regime, is therefore an important hook to assist in firms’ shaping their own culture, and also to provide regulators with the powers to conduct supervisory oversight and to act when needed. But, let me reiterate that it is not the job of regulators to enforce culture and to change culture. If we have to step in, and occasionally we do, the overriding conclusion is that management has failed.
Alas, none of these measures are likely to work much. These things are pretty much inbuilt and historical. Moreover, there is no guarantee that once culture is set, it will continue. Change of senior management who do not believe in culture and history undo all the goods of the past and then sow the seeds for eventual destruction of the firm..