Bad Apples or Bad Barrels? How Effective Culture Mitigates Conduct Risk - Director General Derville Rowland

25 October 2018 Speech

 Derville Rowland

Speaking at the Conference on Culture, Diversity and the Way Forward for Corporate Governance, Trinity College Dublin.


Like other regulators worldwide, the Central Bank’s immediate focus in the wake of the financial crisis was on strengthening the solvency and stability of the banking sector and enhancing protections for consumers.

But there was another fundamental issue that needed addressing. And so our focus widened to consider cultural issues, in recognition of the extent to which culture within firms contributed to the crisis in the first place.

Building on this work, in July, we published our report on current cultures and behaviours and associated risks in the retail banks.

I would like to share with you the key findings and recommendations contained in that report, which builds on earlier work the Central Bank has undertaken on culture, and to consider the lessons to be drawn for the wider financial services sector.

I also look forward to hearing from our speakers and panellists about recent scholarship and practice in the area of Behaviour and Culture and to discuss possible tools that might be used by financial services firms to improve organisational culture to the benefit of their customers, employees and shareholders.

The Red-Faced Anthropologist

Financial Times Deputy Editor Gillian Tett admits she used to be embarrassed to tell bankers and regulators she trained as an anthropologist as only maths, economics or astrophysics seemed to count in their world.

Now, that has changed. In a recent broadcast marking the tenth anniversary of the financial crash, she argued that to understand finance you have to look at what creates trust, what binds people together, what shapes how they behave. In short, you need to look at culture.

It is hard to define culture, but you can think of it as a system of shared values and norms that shape behaviours and mindsets within an institution – the unwritten rules or the way things are down around here. Culture is a matter for each individual bank in the first instance, and no two cultures will be precisely the same. However, organisations that have an effective culture share a commitment to high standards and values.

Yet ten years after the financial crisis, public trust in financial institutions remains very low.

This is hardly surprising given that, in the years since the financial crisis, global banks’ misconduct costs have reached over $320 billion following a series of scandals which have raised questions about whether the underlying culture in financial institutions is driving bad behaviour.

This lack of trust is particularly evident in Ireland. Of 28 markets surveyed, Ireland is the least trusting of the financial services sector, according to the 2018 Edelman Trust Barometer. Matters have not been helped by the fact that, in the years since the financial crisis, the banks denied their customers a tracker mortgage or put them on the wrong rate. These failings had a detrimental and, in some cases, devastating impact on customers, up to and including the loss of their homes and properties in some cases.
It was only following intervention by the Central Bank that banks really began to put matters right. As of August 31st, lenders have identified circa 38,400 affected customers and paid €580 million in redress and compensation.

Bad apples or bad barrels?

Given that misconduct can cause consumer detriment and, indeed, threaten the safety of financial institutions, regulators are increasingly focusing on how firms manage conduct risk, which arises from inappropriate, unethical or unlawful behaviour. There is also an increasing focus on culture, which drives behaviour and, ultimately, customer outcomes.

While the role of “bad apples” in driving misconduct cannot be ignored, there is increasing interest in the role of workplace culture, or the characteristics of the barrel in which the apples are stored. A telling study among US financial advisers found that seven per cent of advisers on a national register have some form of misconduct on their record.

Under the bad apple theory, you would expect to see such misconduct randomly scattered across the industry, but the study showed some firms had significantly higher or lower offending rates. That suggests some firms are doing much better than others at creating an environment where bad behaviour is not tolerated and therefore happens less.

Like other regulators worldwide, the Central Bank is increasingly insisting that firms comply, not only with our regulations and codes, but also that the people who lead the firms we regulate and supervise set the right tone from the top and create a culture that minimises the risk of misconduct.

Be as serious about values as about valuation

In business, of course, shareholder value and the bottom line are important. But it is also important that financial institutions operate within the regulatory framework and that their leaders build a culture that serves their customers and the wider economy in which we license them to operate. Indeed, when Christine Lagarde, Managing Director of the International Monetary Fund, was in Dublin in June she spoke about how “those working in the financial sector must be as serious about values as they are about valuation, and just as passionate about culture as they are about capital.’’

During the course of the Central Bank’s Tracker Mortgage Examination, we detected a number of cultural indicators that were standing in the way of good consumer outcomes. For example, we found banks adopting a narrowly legalistic approach rather than embracing a customer-focused perspective; assigning insufficient resources to the Examination; or offering initial compensation proposals that fell well short of our expectations.

The Behaviour and Culture Reviews – a snapshot of current behaviour

The Behaviour and Culture Reviews of the Irish Retail Banks provide a snapshot of the current behaviour of the executive leadership teams at AIB, Bank of Ireland, permanent tsb, Ulster Bank and KBC. When we carried out our reviews we decided to use a blend of our own Consumer Protection Risk Assessment Framework and tools developed by De Nederlandsche Bank (DNB), leaders in the field of behaviour and culture. The team held interviews with staff in each of the five retail banks - primarily members of the executive committee, but also members of the board.

To give you a sense of the scale of the operation, we held interviews with 75 senior executives. That amounted to 112 hours of interviews - each resulting in transcripts of up to 45 pages - which the team then analysed. The key source of data on which the Behaviour and Culture reviews are based is therefore the perceptions of those senior interviewees themselves.

The good news is that the reviews found that all five retail banks have recently taken steps to reinforce the consideration of the consumer interest. However, the consumer-focused cultures at these banks remain under-developed and all five banks still have a considerable distance to travel.

The reviews revealed patterns in leadership, strategic decision-making and mindset that may jeopardise the successful transformation towards a consumer-focused culture.
For example, several executive committees displayed ‘firefighting behaviour’, focusing on urgent and short-term issues. This may be a remnant of a crisis-era mindset, which persists due to the need to solve legacy and regulatory issues, often under intense media and political scrutiny - which is, of course, to be expected given the banks’ role in the crisis.

The reviews raised concerns with respect to leadership styles. In some banks, there is occasional reversal to ‘command and control’ styles cultivated during the crisis.

Finally, the reviews produced concerns around over-optimism regarding the successful transition to a consumer-focused culture. Many banks used the crisis as a baseline against which they measure progress. They felt confident that, if their bank could survive the crisis, they were well-placed successfully to complete the current organisational transformations.

Banks setting the bar too low

In short, they are setting the bar too low and underestimating the scale of the challenge ahead. We also found there was a need to empower senior staff to make decisions in order to decrease the decision-making burden on the leadership teams. Many senior managers continue to seek executive guidance and decisions on operational matters. This leads to congestion of executive decision agendas to the detriment of long-term transformation efforts.

The Central Bank also conducted Diversity and Inclusion assessments as part of the review. You will hear more on this topic from my colleague, Ed Sibley, and his panel, later today. While culture is in the first instance a matter for the firms, regulators also have a role to play.

Specifically, we have asked the five banks to develop action plans to mitigate the risks identified in our reviews.

Building on our earlier work on culture, banks can also expect further changes in how we supervise them. We will conduct more intrusive, targeted conduct supervision of those firms that pose the greatest potential harm to consumers including robust challenge of board and executive management.

I have in recent weeks met with the boards of the banks to spell out in person what the Central Bank expects of the boards of directors of financial institutions and their senior management teams and to form a judgment about their mindset and commitment to real change.

My message to board members – both executive and non-executive – is this: responsibility for culture rests with the board and it’s on you when the culture in your organisation fails and results in consumer detriment.

Rebuilding trust – creating an effective culture

But it isn’t just about the banks. It is generally recognised that, in the aftermath of the financial crisis and more recent misconduct issues, most financial institutions need to rebuild trust with their customers, shareholders and the societies where they operate.

As Professor Onora O’Neill, who joins us on the panel today, has rightly pointed out, sensible people will want to place their trust only with trustworthy organisations. And that is where culture comes in. Culture should be driven by institutional standards such as fairness, respect, integrity and honesty. These standards should be promoted from the top down, echoed from the bottom up and be visible throughout the organisation.

The primary responsibility for setting those standards rests with the boards and executive committees. Boards and senior managers should be asking themselves questions such as: Is the tone from the top signaling the right values to staff? Are those values being lived in practice? Are customers’ interests being taken into account when decisions are made in the boardroom and at the executive committee level?

Wells Fargo

 It is worth recalling that Wells Fargo’s 2013 Annual Report made all the right references to the “tone at the top’’ and oversight of its risk culture . But just a few years later the US bank was fined after its staff secretly opened millions of unauthorised accounts.

Yet, there were signals that appeared many years before the board was made aware of the potential seriousness of the sales incentive issues at Wells Fargo. These included employee exit interviews and terminations, whistleblower reports, customer complaints, media reports and lawsuits.

This highlights the importance for boards of obtaining timely and relevant information that will help them ensure that the culture they have defined for their organisation is reflected on the ground.

Net Promoter Scores may be a valuable tool to measure customer satisfaction, but they only tell one part of the story. It is important to focus on other measures too – such as monitoring customer complaints to the institution itself and to the Financial Services and Pensions Ombudsman.

I would also highlight the importance of boards ensuring adequate product oversight and governance – not just when products are launched, but also when they are withdrawn. It is important too that the consideration of the consumer interest is not just tagged on at the end of the product launch or withdrawal process, but is integral to it.

The board must not be blind to issues that senior management chooses not to bring to its attention, rather the board must insist that the correct information is made available to it. In short, the board must ensure that the organisation is not just talking the culture and conduct talk, but walking the talk as well.

Preventing senior people washing their hands of wrongdoing

A lack of accountability is widely seen as a key driver of misconduct and therefore we are recommending individual accountability measures to drive better behaviour. These include proposed Conduct Standards for all staff in regulated firms, such as acting honestly, ethically and with integrity; additional conduct standards for senior management; and standards for businesses.

We are also proposing changes that will significantly reduce the chances of key people in firms being able to wash their hands of wrongdoing. We are recommending to government that a Senior Executive Accountability Regime (SEAR) be implemented through legislation. This would place obligations on firms and senior individuals to set out clearly where responsibility and decision-making lies for their business.

The primary purpose of the Central Bank’s focus on culture is to act as a driver for positive behaviours. We want to support the building of good barrels in which good apples can thrive.

I look forward to hearing from our speakers, panellists and audience members today about how we can ensure that the culture in our financial institutions minimises conduct risk, drives those positive behaviours and delivers for all stakeholders. I will hand you over now to Gráinne McEvoy, Director of Consumer Protection, who will chair the first panel of the morning.