Bank culture: responsibility mapping and 'rolling bad apples'

Global regulators have conducted a full stocktake of efforts underway by banks and their local watchdogs to tackle misconduct risks.

Misconduct risk has reached such giant proportions in the banking industry that it presents as threat to financial stability, according to the Financial Stability Board.

In a new report, the FSB has examined whether bank pay reforms are doing enough to get rid of bad behavior in the fixed income, commodities and currency markets. And whether an overhaul of incentives is helping to improve major financial benchmarks.

Boiling it down, this very significant 89-page stock take identifies ways that misconduct threatens the global banking system.

The first is simply the sheer level of fines, according to the FSB. If the banks are going to continue to be fined large amounts of money - in some cases billions of dollars - this poses a threat to the individual bank’s stability.

Second, the regulator points out that while banks might have adopted a Code of Conduct and a Code of Ethics, if scandals are repeated what other parts of the lender’s governance framework is not working?

Or, if bank employees aren’t following the framework at the level of fair dealings with customers, what other rules are the employees not following?

Rolling bad apples

The FSB report sets out three areas for further work which include responsibility mapping - which goes towards personal accountability - and “rolling bad apples”.

“Work on the former will examine the ways in which responsibility mapping and related tools could be used to mitigate misconduct risk, including through supervision or through enforcing legal obligations constraints.”

Rolling bad apples involves developing a register of people who are fired due to unsuitable behavior at one bank, so they don't resurface at another. 

“This work will try to define and size the problem and explore the current and potential uses of governance frameworks to make employee screening and due diligence more effective.”

Lastly, the FSB will explore how governance mechanisms, like escalation processes, training and non-financial incentives may mitigate misconduct risks posed by the culture of a firm.

According to Kevin Nixon, head of Deloitte Centre for Regulatory Strategy, this high level of regulatory concern is no less in Australia than anywhere else.

“Our regulators have become more proactive. In terms of their effectiveness, I’d say they are in the mix. Everyone is moving on this,” he said.

Ethical, effective culture

Interestingly, the FSB report comes just as the European Central Bank is looking to adopt and build on De Nederlandsche Bank’s ‘behavioral supervision’ approach, which highlights the importance of an ethical, effective culture.

So, what can banks across the Eurozone expect from this new behavioral supervision initiative which is expanding beyond the Netherlands? According to KPMG, one-on-one interviews with board members and senior employees and observation of board meetings by professional psychologists could be on the horizen.

Banks should be reassured, added KPMG, that the ECB is unlikely to start with a close study of individual personalities of board members.

“Instead, like DNB, ECB is expected to focus on collective behavior in areas such as boardroom dynamics, decision making and organisational culture," said the report.

“That said the introduction of behavioral supervision is a game-changer for supervisors and banks alike. Supervisors and banks alike face a steep learning curve. Banks may find the new approach unsettling, but those that embrace the process have nothing to fear - and could reap significant value.”

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