Quantifying culture and its implications for bank riskiness

Joel Suss, David Bholat, Alex Gillespie and Tom Reader explain their recent paper on the Bank Underground blog. The paper finds a statistically significant relationship between organisational culture and bank risk. The effect is substantive – a one standard deviation improvement in culture is expected to reduce risk by 25%.

In sum, a bank’s culture is a leading indicator of its risk. While this claim has often been made, it has been far less frequently substantiated. Our research provides evidence to support it.

This finding has a few implications for banking supervision. First, it suggests that supervisors should seek to measure organisational culture explicitly and use cultural indicators as inputs into microprudential models of bank risk. While culture is already monitored by supervisors qualitatively and directly, via surveys and interviews of bank staff, we suggest it might be done quantitatively and unobtrusively, in ways both more objective and less costly to obtain. Our own composite indicator is an initial attempt that could be further developed, with additional data added. It is also likely that the way we measure organisational culture needs to change over time. As per Goodhart’s Law, if firms are aware that regulators are looking at a handful of indicators to measure their culture, they may seek to manipulate them, or optimise them while allocating resources away from other, equally important practices that make for a good organisational culture.  

Second, our research underscores the importance of analysing firms holistically. Many of our indicators, such as the frequency of internal fraud or customer complaints, are traditionally thought to relate to conduct and consumer protection. However, our research shows they are directly relevant for prudential supervision.

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