Banking Conduct and Culture: A Permanent Mindset Change

After completing this reading, you should be able to:

  • Describe the challenges banks face concerning conduct and culture, and explain motivations for banks to improve their conduct and culture.
  • Explain the methods by which banks can improve their corporate culture and assess the progress made by banks in this area.
  • Explain how banks can structure performance incentives and make staff development decisions to encourage a strong corporate culture.
  • Summarize the expectations by different national regulators for banks’ conduct and culture.
  • Describe the best practices and lessons learned in managing a bank’s corporate culture.

Challenges Banks Face concerning Conduct and Culture and Motivations to Improve Banks’ Conduct and Culture

The Challenges Banks Face concerning Conduct

Bank management, customers, and investors have given much attention to the banks’ culture and conduct over the last decade. Additionally, government, regulators, and supervisors have increased scrutiny of issues related to conduct and culture since the last financial crisis. Ultimately, banks have invested significant effort in boosting their conduct and culture. However, the banking industry still has a negative reputation, and it still needs to mend its trust despite all these efforts.

Banks should fully embed a conduct and culture lens in everything they do as a part of the normal business. As society and the competitive landscape evolves, banks cannot afford to be complacent about their trust and reputational problems. Cultural improvement is inevitable if the trust is to be restored in the banking system. Here, we discuss some of the challenges that banks face in mending the negative reputation and trust issues.

Changing sources and scope of conduct issues: It is a challenge for banks to manage the changing sources and scope of conduct issues as well as to recognize that the pressure on conduct and culture is changing, and expectations are evolving. Changes are imposed on the banks by external forces, for example, digitalization, leading to a continuous evolution of customer expectations, and dynamic competitive pressures. Consequently, banks should recognize that the business environment is constantly evolving. There is a need for the bank to improve its culture, reinforce the levers, and align conduct and risk management practices with everyday business to restore trust in banking among all stakeholders.

A challenge of understanding the challenges of putting the customer first and balancing potential conflicts of interest: The banks need to focus on customer satisfaction as they work towards achieving more sales for increased profitability. Balancing the two is always a challenge for many financial institutions.

Tackling the industry-wide issue of “rolling bad apples”: Individuals with poor conduct records have the freedom to move from one bank to another. This is because there is a legal prohibition that limits a bank from publicizing reasons for one’s dismissal, and thus, bad players in the industry are able to move from one bank to answer.

It is a challenge reconciling the appropriate form and level of public disclosures on culture and conduct: There are concerns about money laundering, as well as other concerns that involve the banks taking the initiative of knowing their customers. Banks spend lots of resources conducting research, and most of the time, they might be researching the same individual or organizations that were already researched by a different bank. An excellent solution to prevent double work would be creating a utility for sharing information. However, legal roadblocks and privacy concerns are standing on their way.

Motivations to Improve Banks’ Conduct and Culture

To mend trust and reputational issues and fulfill the role of banks in society, bank culture and conduct play a crucial role. The following are some of the points that give a bank the impetus to improve its conduct and culture.

To build trust and reputation after the global crisis: After the 2008-2009 global financial crisis (GFC), there was a rapid decline in the reputation of trust in the banking industry. Improving bank culture and conduct was inevitable and a priority from the perspective of bank managers, supervisors, customers, investors, and government regulators. The industry suffered penalties of US$350-US$470 billion in fines and settlement charges for matters related to poor conduct. Reports of misconduct had a shock effect that eventually brought down the reputation of the entire banking sector. The restoration of good conduct and culture is required to ultimately regain public trust.

Continuing low trust levels and negative reputation: Despite the industry putting a lot of effort into conduct and culture, they still suffer from a bad reputation. There is a need to rebuild banks’ reputation and regain public trust, and this calls for improvement in their conduct and culture. The trust levels remain low relative to other industries and has not yet resumed to the pre-crisis levels.

Competition from alternative service providers: There is competition from new firms ready to provide banking services, for example, fintech start-ups, technology firms, retailers, and telecom companies. Banks have no choice but to try and regain trust. To survive, banks require a great improvement in conduct and culture. There is also the concern of acquiring and retaining talents for employees, which depends widely on a proper culture and conduct.

To stabilize the broader financial system: Banks will be better at fulfilling their role in society, and conclusively contribute to the stability of the financial system if they practice good culture and sound conduct. Banking services are considered a public good, and failure of this particular function affects not only the shareholders but also the entire economy. Banks are executing the needed policy changes and processes to improve culture and conduct to mitigate incidents of potential misconduct. However, culture and conduct have to be fully integrated into how banks do business.

Possibility of a build-up of culture and conduct fatigue: There are bigger chances for progress related to culture and conduct to be initialized and then forgotten. However, good culture and conduct should be internalized as the way of doing business. Additionally, it should not be segregated from other business activities. Sustainable cultural changes should insist on improving the leadership capabilities. This is to put more focus on including management skills rather than purely building up financial awareness. Moreover, substantial management skills are required to develop an atmosphere that is psychologically safe and empowers employees to work genuinely at the bank.

Move towards refined and effective management style: The banking industry has, in the past, managed business and the people by the use of quantitative metrics, for example, the volume of sales and profits, and did not pose any challenges to assess. Driving sustainable cultural change in banks requires leadership skills that were not a point of focus in the past. There is a need to adopt a new focus point, such as psychological safety, which requires greater management skills. Most banks that did not give importance to improving management and leadership capabilities are now forced to invest in the same to catch up with the lost time. There is, therefore, a need to improve the culture to catch up with the evolutions.

Methods of Improving Banks’ Corporate Culture

In this section, we discuss crucial suggestions for boosting conduct and culture for banks to challenge their cultural foundation

Adjusting hiring processes: Bank leaders should consider how culture is integrated into the recruiting and hiring processes and how new employees are assimilated into the culture. Firms should always consider cultural fit during the recruitment process; this also includes the CEO. The board needs to hire a CEO who fits in the culture. Because the board should outlast individual CEOs, as their tenures are relatively short, they can transmit the culture to a new CEO to ensure that the bank survives transitions.

Improving training and communication: Some companies have started culture change initiatives by incorporating training and awareness programs. Participants emphasized the importance of a coordinated and consistent reinforcement over time. Senior executives are experimenting with new forms of continuous communication with a broader audience. For example, starting a blog, on which examples of acceptable and unacceptable behaviors can be shared, and people can be recognized for positive behaviors. The internal audit functions have experience assessing culture as an informal part of their work and are therefore equipped to shift to more formal assessments.

Balancing financial incentives: Banks’ incentive structures should be designed and controlled so that they sustain good customer outcomes. Incentives linked to sales should utterly be removed to enable the bank to move towards this goal. Banks should revise their sales incentive structures for the frontline salespeople and all layers of management. Banks have reduced their focus on sales performance, but have not yet created a sustainable culture of good conduct. One problem is that drastic changes in these incentives can potentially cause unintended consequences. Workers may take actions to protect it, which could be an incentive to take unethical steps, for example, not reporting a loss or shuffling losses into a different account. The main challenge is finding the balance and achieving it. It is also a challenge to adjust variable pay in this sector since competition for talent is global, and even efforts to address this issue of compensation vary by jurisdiction. The United Kingdom and European Union, for instance, are imposing caps on incentive compensation. However, this is not the case in the US and Asia, making it hard to have coherent global pay structures.

Increasing individual accountability: The right culture should encourage everyone to hold the other party account. Many banks are incorporating new elements into employee evaluations, such as including values into the appraisal process. If one doesn’t receive a minimum score for each value, they don’t receive their bonus, or they do not advance. This is a bit extreme, but it may be the only way to bring this to the ground. Strengthening accountability is one of the most important parts of improving an organization’s culture. However, sharpened individual accountability may lead to unwanted consequences. however, the focus on accountability raises some additional concerns, including:

  1. Uncertainty about responsibilities: There is no clarity regarding what people are being held accountable for, for example, can a penalty be extended to someone for not doing something wrong, but for their awareness of it? Responsibility should be clear as to who is ultimately accountable.
  2. Privacy concerns: There are legal prohibitions that limit how much a firm can publicize the reasons for someone’s dismissal. That means that dismissal may be the penalty one gets for bad behavior, but since this cannot be publicized, they have the freedom to get a job in a different bank. Since the knowledge remains within the institution, bad actors can simply go elsewhere.
  3. Creating fear: The focus on accountability may create a lot of negative conduct incentives. People may think it’s better to do nothing since the bank severely penalizes everything deemed as negative.

Expanding monitoring and measurement: An organizational culture encompasses behaviors that are difficult to assess and interpret. Data collection helps with assessment; however, understanding culture requires considering the bigger picture and seeing how the various pieces fit together. There are various forms of monitoring that banks should engage in:

  1. Employee surveys: Surveys provide a base for understanding the firm’s cult(c) Leading indicators: There is a significant point of concern in measuring or grading the obtained information. It leaves an option of just looking at the result, for example, the number of violations, things which are mostly post-facto rather than ex-ante. Many firms are identifying leading indicators to alert them of possible culture issues, for example, whether workers skip compliance classes, violate personal trading rules, breach market-risk limits, among others. This is to try to predict future behavior.ure and a way of tracking changes over time. They are a useful source of feedback on culture change efforts. However, the bank may face a challenge of what to do about the information obtained from the surveys.
  2. Hotlines, focus groups, and town hall meetings: Banks are offering more opportunities for employees to ask questions and share concerns with senior management directly or via mechanisms such as employee hotlines and focus groups. These structured interviews and focus groups are a more effective approach. Some banks may have an external conduct adviser who, alongside the chairman and CEO, meets with new employees each year to address these issues.
  3. Leading indicators: There is a significant point of concern in measuring or grading the obtained information. It leaves an option of just looking at the result, for example, the number of violations, things which are mostly post-facto rather than ex-ante. Many firms are identifying leading indicators to alert them of possible culture issues, for example, whether workers skip compliance classes, violate personal trading rules, breach market-risk limits, among others. This is to try to predict future behavior.
  4. Behavioral monitoring: Firms are increasing the monitoring of a broader range of behaviors, such as chat room activity.
  5. Expanding the role of control functions: Internal audit and risk functions are increasingly including cultural indicators in their work. The relationship between the control functions and the businesses can also offer valuable insight. When some kind of “cultural breach” occurs, bank leaders try not only to be sure they learn any directly applicable lessons and remediate the issue, but also to make sure the problem is not treated as a one-off. With adverse outcomes, problems with culture become more evident, and failures are always insightful.

Adapting board oversight: The level of detail required to handle operational issues as well as monitoring the behavior of tens or even hundreds of thousands of employees is a significant challenge to the directors of big firms. What they see or are presented with might look okay. However, they might discover later that something may be wrong. Is culture something boards are genuinely worried about, or do they view this as just the flavor of the month from regulators? The board is responsible for the behaviors of all of the firm’s employees everywhere, and all of the time, the consequences of misconduct are now quite serious. The board has an important part to play in establishing and supporting culture change.

Structuring Performance Incentives, and Making Staff Development Decisions to Encourage a Strong Corporate Culture

Structuring Performance Incentives

In the past, banks have been using incentives for employees who manage to make more sales. However, this was done without consideration of customer satisfaction. After the global financial crisis of 2008-2009, regulatory bodies require banks to balance their financial incentives. The following are some of the ways in which banks are handling these incentives.

Banks should include cultural and behavioral considerations into the performance scorecards: Most banks in the UK and Europe have resulted in new remuneration schemes and have also incorporated cultural and behavioral concerns into performance scorecards, especially at senior management levels. This cultural change is due to the Financial Conduct Authority (FCA) and the European Banking Authority (EBA) guidance. Banks are at different stages of formalizing these measures, applying them to middle management levels and below, and ensuring consistency in application.

Penalties for conduct breaches: It is much easier to evaluate direct results than behaviors, and challenging to penalize high performers who do not fall in line with cultural expectations. Boards and management must nonetheless take this step, and be willing to terminate employees for conduct breaches when necessary. When management unevenly upholds standards of behavior, it sends a powerful message to all team members of what is essential in reality regardless of the stated values. Banks are, therefore, more willing to act on and publicize breaches of conduct, with some having signaled when conduct failures have led to terminations.

Incentives should be based on team goals and customer satisfaction: Recent years have seen cases of conflicted remuneration models that incentivize overly aggressive sales behaviors that result in harmful outcomes for customers. Some individual firms have removed sales-focused incentives for frontline staff, opting instead for alternative measures such as those based on team goals and customer satisfaction outcomes.

Commissions should be based on services provided to the customer: Banks should shift compensation away from basing it on profitability metrics to paying a commission based on services provided to the customer, which will ensure the client is happy with the service before the commission is paid. Client’s happiness is ascertained by a third party who is employed to collect client satisfaction’s key performance indicators.

Reeducating staff to assess customer needs better: The changes in incentives require efforts in reeducating banks’ staff on ways of assessing customer needs better and making suitable recommendations. There is also a need to introduce new service tools and routines for the frontline staff.

Minimizing reliance on compensation as a management tool: Compensation is not the right instrument for effectively influencing behavior. It is, therefore, wise for organizations to minimize the dependence of compensation as a management tool. The banks’ managers should look for real-time coachable moments to drive employee behaviors rather than only ex-post compensation measures. There is also a potential impact on culture that this change has, if done in isolation.

Using termination as a teaching moment: Banks are beginning to look at the potential benefits of using a breach of conduct incidents and terminations as a teaching moment. However, there are potential risks of going against the privacy, confidentiality, and employment law. It is difficult dealing rapidly and forcefully with terrible breaches of conduct, especially in certain jurisdictions with strong employee protection. The current climate of social justice campaigns and activist investors forces organizations to align ethical and legal considerations.

Making Staff Development Decisions to Encourage a Strong Corporate Culture

To stir up a strong corporate culture, a bank should consider making the following decisions:

Implementing training programs on conduct and culture: Employees should get training on the expectations in terms of behavior that would help them understand how values and principles translate into the day-to-day responsibilities and expectations. Although banks have value and mission statements, there is very little guidance for employees to translate high-level statements into what they mean specifically for them and their everyday job to live up to the expectations of the institution. There is a need to map the culture to the practical, providing actual examples of how the culture must be lived.

Offering the right training for the right people and at the right time: There is an increase in the level of training on all aspects of conduct, an exercise that can have a numbing effect on staff with employees starting to tune out, leading to the opposite effect as intended. It is, therefore, key to have the right training for the right people and at the right time. Banks should not push everyone through unnecessary training.

Changing the hiring and promotion processes: Banks are increasingly applying conduct screens to making promotion and external hiring decisions. Some banks have stepped up their hiring practices to better assess recruits’ alignment with the organization’s conduct and culture, for example, by including conduct interview questions, ethical screening, and several forms of personality assessments.

Investing in surveillance technology: In recent years, there has been an active investment in surveillance technology at banks starting with capital markets businesses but increasingly broadening in scope to other areas. The technology is rapidly evolving to support more capabilities. However, there are ethical concerns about the acceptable degree and level of employee monitoring. With the increased monitoring capabilities, banks should carefully balance the need to manage conduct with the need to provide employees with a level of privacy and trust.

Expectations by Different National Regulators for Banks’ Conduct and Culture

Regulators and supervisors across the globe have increased attention to and expectations regarding conduct and culture. Examples include:

United Kingdom

The Financial Conduct Authority (FCA), in conjunction with the Bank of England and Her Majesty’s Treasury, issued the ‘Fair and Effective Markets Review,’ which recommended the need to raise standards, professionalism, and individual accountability, as well as promoting forward-looking conduct risk identification and mitigation. The FCA implemented the Senior Managers and Certification Regime to increase individual accountability and governance via banks’ senior leadership.

Japan

The Japanese Financial Services Agency is a government agency and an integrated financial regulator responsible for overseeing banking, among other sectors, for ensuring the stability of the financial system of Japan. JPSA has signaled its intention to shift focus on firms’ governance and institutional cultures. It will do this by engaging the firms’ senior management and auditors and prompting the financial firms to focus more on consumer satisfaction as well as other stakeholders’.

Hong Kong

The Securities and Futures Commission (SFC) is a Hong Kong’s statutory body responsible for regulating the securities and futures markets in Hong Kong. It is responsible for fostering orderly securities and futures markets that protect investors and helps promote Hong Kong as an international financial center. SFC’s Manager in Charge regime aims to increase the accountability of senior management and managers of key/control functions. The Hong Kong Monetary Authority (HKMA) bank culture reform was launched in 2017.

In December 2018, the HKMA announced supervisory measures for bank culture, for example, self-assessment, focused reviews, and culture dialogues, to gauge the progress of bank culture reform in Hong Kong.

Singapore

The Monetary Authority of Singapore (MAS) is Singapore’s central bank and financial regulatory authority responsible for administering the various statutes about money, banking, insurance, securities, and the financial sector in general, as well as currency issuance. It has drafted proposed guidelines on individual accountability and conduct via banks’ senior leadership.

China

The China Banking Regulatory Commission (CBRC) was formed as China’s independent banking regulator in 2003. CBRC has published Conduct Management Guidelines for banks, designed to facilitate reporting of improper conduct in banks. The process is designed to establish norms for long-term monitoring and inspection of bank practices. The People’s Bank of China has also underlined the importance of conduct and culture for the leadership of major banks via its support for the G30 recommendations.

United States

The Office of the Comptroller of the Currency (OCC), the Financial Industry Regulatory Authority (FINRA), the Securities and Exchange Commission (SEC), and the Consumer Financial Protection Bureau (CFPB) have increased focus on culture and conduct from the Federal Reserve Banks. In particular, the Wells Fargo sales practices scandal led the OCC to launch a multiphase industry-wide review. In his speech, The Federal Reserve Bank of New York president and CEO John Williams expressed a sense of urgency in addressing banking culture. He explained that there is a need to ensure that bank management and boards are exerting strong and effective leadership with strong governance. That means holding management and boards of directors to high standards in terms of culture and conduct.

Canada

Financial Consumer Agency of Canada (FCAC) is a Canadian government independent agency that is responsible for enforcing consumer protection legislation and regulations. FCAC is also responsible for providing programs and information that help consumers understand their rights and responsibilities, especially when dealing with financial institutions. (FCAC) launched a business practices probe, focusing on bank employees’ obligation to obtain customer consent and provide proper disclosure about fees and costs when selling new products. The Office of the Superintendent of Financial Institutions (OSFI) launched a review of domestic retail sales practices. The FCACs related report, released in March 2018, noted insufficient controls at Canada’s largest banks to mitigate the risk of misselling and breaching market conduct obligations.

Australia

The Banking Executive Accountability Regime (BEAR) is pursuing to better standards of behavior and accountability. The Banking Royal Commission (BRC) was established in 2017 by the Australian government to inquire into and report on misconduct in the banking and the financial services industry. It was established to investigate incidences of misconduct in the banking superannuation and financial services industry that was pointed out by the Australian media. The Report of the Royal Commission made recommendations relating to institutions and individuals about dishonest misconduct; the regulators were charged with the responsibility for taking actions.

The Best Practices and Lessons Learned in Managing a Bank’s Corporate Culture

After the 2008-2009 financial crisis, the banking industry has tried to make improvements from their previous mistakes that may have contributed to the crisis. The group of thirty in their publication of 2018 noted some of the lessons learned in the journey to reform the banking sector. The following are the lessons learned:

Managing culture is not a one-off thing: Culture is not static, and therefore its management should be a continuous effort and should receive a constant and permanent reinforcement. The firm must, therefore, constantly adapt new culture to align with the changing strategies and business conditions. The banking industry is evolving with time, creating a need for the banks to ensure that the cultural efforts are responsive to potential changes in the desired outcomes.

Leadership always matters: Conduct and culture must be embedded from the board to senior management and through middle management down to the teller, and through all business units and geographic locations. The board should be aware of as well as involved in defining and guiding the culture. The role of the board is to define the purpose of the organization and ensure strategy, communications, policies, processes, and practices are all aligned with the desired culture. Senior leaders need to involve middle management to reinforce further firm values and intended behaviors in their respective areas of oversight.

The scope of conduct management is changing from misconduct to conduct risk management: Misconduct should be defined more broadly to entail more than just misbehavior by an employee’s desire for personal gain. It should cover intent, negligence, failure of judgment, all stakeholders, harm on customers and colleagues, among others. Banks should also focus on improving and promoting good conduct as they consider reducing misconduct.

Management of culture requires a multipronged approach and the simultaneous alignment of multiple cultural levers: Culture is not empirically good or bad, but should be right for the bank based on its values, strategy, and business model. The different levers of culture should be aligned with the desired outcomes. Cultural levers include structural elements such as policies, organization, processes, and technology, as well as intangibles such as tone from the top, beliefs, and perceptions. A bank’s various cultural elements are a true reflection of its values and priorities.

A more diverse set of views and voices in senior management will lead to sustainable outcomes for all stakeholders: Diverse thinking, problem-solving, and leadership styles will help organizations achieve better results through greater questioning, challenging, creativity, and innovation. Diversity in leadership teams can also be helpful as it makes employees feel safer in raising concerns and escalating issues. Most institutions have recently put more focus and importance on hiring, retaining, and empowering diverse employees. Gender disparity in pay is gaining attention as an emerging issue in the banking industry.

This disparity can partially be attributed to issues with equal pay for equal work as women hold fewer senior/highly paid positions than men. These imbalances can create cultural issues such as bullying, harassment, among others, that can negatively impact clients.

Cultural norms and beliefs cannot be explicitly measured. However, the behaviors and outcomes that culture drives can and should be measured: The banking industry has not yet come up with metrics or their measurements; measuring culture is thus very challenging even though it is necessary. A set of indicators is necessary to show when employees are in line with the firm’s strategy, core principles, and even goals. There should be objective and meaningful metrics through which the management can observe employees’ behaviors. Having this in place will ensure that a healthy culture is maintained and conduct issues are detected before they become problematic. Culture is not constant as it evolves and is influenced by various factors, including company strategy, acquisitions, evolving customer needs, or technological advancements, among others. The more mature banks, in terms of culture and conduct reporting, provide the following lessons on metrics:

  • The report should focus on metrics that are meaningful to the purpose and value of the firm.
  • The metrics should be seen over time and analyzed as a trend rather than a single number or point in time.
  • The details are critical, and the board and senior management should focus on the anomalies, exceptions, and the tail, given that in the summary view, the issues can be buried and lead to a false sense of complacency.
  • The report should include commentary and explanation of the data, and the reporting operating model should also include the ability to do further analysis and investigation where needed.
  • The reporting should focus on conduct rather than narrowly on misconduct.
  • The reporting tool should be flexible and provide multiple views, geographic focus, and types of metrics needed to meet the needs of multiple audiences, for example, the board, senior management, business heads, and various second-line functions.

Deriving metrics from company values is a multistep process: Deriving metrics from company values requires organizations to answer some challenging questions about values, identifying stakeholders, and outcomes for each. The information obtained should then be used to communicate desired behaviors and translated into observable metrics. Banks need to start on a data exploration and analysis effort to ensure that the data needed for the desired metrics are available or can be readily collected. Several tools, including internal surveys, audits, and customer assessments, are particularly useful in gathering data for given metrics.

Restoration of trust will benefit the industry as a whole: The restoration of trust will benefit the whole banking sector. Therefore, industry-wide dialogue and best practices sharing are essential elements in achieving a healthier banking sector. The banking industry should consider mechanisms of collaboration to develop cross-industry comparisons of their progress on culture and conduct. This collaboration and comparisons will help provide banks with a view into their culture relative to those of peers. Further, such benchmarking results can provide banks with an objective basis for introspection and constructive challenge, guarding against overconfidence in their approaches.


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