Bailey stated that the culture of firms and the people that make them up, is of the utmost importance to financial regulators.
“Culture is a product of a wide range of contributory forces: the stance and effectiveness of management and governance, including that well used phrase “the tone from the top”; the structure of remuneration and the incentives it creates; the quality and effectiveness of risk management”.
“As important as tone from the top, the willingness of people throughout the organisation to enthusiastically adopt and adhere to that tone. Out of this comes an overall culture. It is not something that has a tangible form”.
Bailey acknowledged that as a supervisor, it can’t go into a firm and say “show us your culture”. But it can, and does, tackle firms on all the elements that contribute to defining culture, and from that it builds a picture of the culture and its determinants.
“Culture has laid the ground for bad outcomes, for instance where management are so convinced of their rightness that they hurtle for the cliff without questioning the direction of travel. We talk often about credit risk, market risk, liquidity risk, conduct risk in its several forms. You can add to that, hubris risk, the risk of blinding over-confidence”.
The UK regulator seeks to ensure that firms:
- Have robust governance, which includes appropriate challenge from all levels of the organisation
- Promote the acceptance that not all news can be good and the willingness to act on and respond promptly to bad news
- Ensure that remuneration is structured to ensure that individuals have skin in the game; a meaningful amount of past remuneration is retained or deferred and for senior people is at risk should problems emerge
- Ensure that risk management and internal audit in firms are effective to root out poor incentives and weak controls
Bailey reinforced the point that culture begins and lives with firms and that responsibility is the central plank of the new Senior Managers Regime; this includes responsibility for forming and implementing a positive culture throughout the organisation.
“Responsibility, as embedded in the Senior Managers Regime, is an important hook to assist in firms’ shaping their own culture. If we have to step in, and occasionally we do, the overriding conclusion is that management has failed”.
“Firms exist to service customers, which of course means that service includes the notion of not exploiting customers, a value one might expect to be given in an organisations culture”.
“Trust is important. Consumers need to be confident in the firms that they choose to use, and inevitably trust is an important part of that confidence”.
“Likewise, as supervisors, our judgements are inevitably conditioned on whether we can trust the people with whom we deal. Good culture is a product of trust and it matters a lot for both prudential and conduct regulators”.
For Boards and Senior Executives to really understand and influence culture(s) in their firms, they need to understand the behaviours that exist all levels.
Traditional econometric reporting will not suffice. For example, the regulator mystery shops, reviews complaints and FOS determinations. It also undertakes thematic reviews and market studies. All geared towards what actually happens!
Observation is therefore key if Directors are to be confident that their firm is:
- delivering good customer outcomes
- preserving market integrity and
- not distorting competition
This is the world of behavioural regulation. For further information, see BRG white paper: The Behavioural Regulators’ Agenda
The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions, position, or policy of Berkeley Research Group, LLC or its other employees and affiliates.