Reforming Culture (in financial services) for the Long Term

I just blogged about why importance of preserving local culture and values as SBI merges its associate banks.

So, one just came across this NY Fed chief William Dudley Speech in London on reforming culture in finance. In evening he participates in a panel discussion titled: Worthy of Trust? Law, ethics and culture in banking.

Dudley who was under fire for corporate misgovernance a NY Fed has earlier also made remarks on culture.

In the recent speech he says:

As I have argued before, incentives shape behavior, and behavior drives culture.  If you want a culture that will support your long-term business strategy, you need to align incentives with the behaviors that will sustain your business over the long haul.6

Incentives—compensation and promotion, in particular—are powerful tools for communicating the conduct and culture you desire for your firm.  Of course, the cultures of firms can and should vary.  But, the culture of every bank should share a common theme: stewardship—a word that implies professional care, exercised year after year for the benefit of the firm and its stakeholders.  A commitment to the long term must be at the core of banking.  Incentives within a firm should support that goal, not undermine it.

My emphasis on incentives is not new, but it bears repeating.  Bad incentives were a key contributing factor in the financial crisis.  In the United States, the Financial Crisis Inquiry Commission concluded that “Compensation systems—designed in an environment of cheap money, intense competition, and light regulation—too often rewarded the quick deal, the short-term gain—without proper consideration of long-term consequences.”7   This theme applied to all levels of banking organizations.  One notable example was mortgage brokers, who were paid based on the volume of loans they generated, not their quality.8

The financial crisis came to a head in the fall of 2008.  Fast forward eight years to the fall of 2016.  Wells Fargo’s chairman and CEO resigned after regulators uncovered what appeared to be widespread fraud in the retail bank.  Compensation, once again, seems to be at the center of a scandal.  Neighborhood bankers were paid based on the volume of new accounts opened, apparently with utter disregard for whether customers wanted them or even knew about them.  And, like mortgage brokers in the early 2000s, it appears that job security depended almost exclusively on meeting targets, regardless of how those targets were met.  There was a serious mismatch between the values Wells Fargo espoused and the incentives that Wells Fargo employed.9  

Investigations into what happened at Wells Fargo are continuing, so I will wait before drawing more definitive conclusions.  For now, though, it is sufficient to note the powerful role—for good or for bad—that incentives can play in an organization.  I understand that making progress on culture is difficult.  But, if you want the next round of metrics to look better than the last, use a powerful lever—use incentives. 

Today’s discussions—here at Mansion House and later at the Bank of England—are evidence that the issue of culture is important to the private and public sectors alike.  We have to keep working on this.  The public sector must continue to shine a spotlight on the issue, and the industry must continue to demonstrate that it is taking responsibility for its culture.  And, culture cannot be a subject that only receives attention because bad conduct has occurred in the recent past. 

I am convinced that a good or ethical culture that is reflected in your firm’s strategy, decision-making processes, and products is also in your economic best interest, for a number of reasons:

  • Good culture means fewer incidents of misconduct, which leads to lower internal monitoring costs.
  • Good culture means that employees speak up so that problems get early attention and tend to stay small.  Smaller problems lead to less reputational harm and damage to franchise value.  And, habits of speaking up lead to better exchanges of ideas—a hallmark of successful organizations.
  • Good culture means greater credibility with prosecutors and regulators—and fewer and lower fines. 
  • Good culture helps to attract and retain good talent.  This creates a virtuous circle of higher performance and greater innovation, and less pressure to cut ethical corners to generate the returns necessary to stay in business. 
  • Good culture builds a strong organizational story that is a source of pride and that can be passed along through generations of employees.  It is also attractive to clients.
  • Good culture helps to rebuild public trust in finance, which could, in turn, lead to a lower burden imposed by regulation over time.  Regulation and compliance are expensive substitutes for good stewardship.

Good culture is, in short, a necessary condition for the long-term success of individual firms.  Therefore, members of the industry must be good stewards and should seek to make progress on reforming culture in the near term. 

Well, there was a time when NY Fed would never discuss such issues. They were seen as soft and not of any importance. NY Fed was more about hard finance and fancy stuff.

 

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