By: Shazia Khan Afghan
The term “alchemy” has a rich and diverse origin and, hence, meaning. For example, alchemy has been defined as a chemical science, a speculative philosophy, and even a power that transforms something in a mysterious or impressive manner. This paper discusses the mysterious nature of the conclusions of the Group of Thirty (G-30) Report on Banking Conduct and Culture. In particular, how the recommendations lack a quantitative scientific or empirical basis. Despite these shortcomings however, this paper concludes that the normativity of the report should not be understated. The gravitas, leadership and global influence of the G-30 are irrefutable. Equally, many of the conclusions of the G-30 report are corroborated by independent assessments of banking culture and conduct, which are based upon more rigorous empirical investigations.
Culture and conduct in the banking industry
Following a series of market misconduct scandals, hefty regulatory fines and intense legal and regulatory reform the mood has lifted from anger and incredulity to reason and self-reflection. The focus of the supervisory agencies has now moved towards improving culture in banking and financial services. The idea that organisational culture provides the stimulus for individual and collective banker behaviour or conduct appears to have been accepted as a universal truth. Good culture drives good conduct. If you can find a way to cure banking culture, then you might also remedy banking conduct. It can therefore hardly be surprising the public enthusiasm for regulatory agencies to perform what would appear to be a very promising alchemy.
So, for example, the recent decision by the UK Financial Conduct Authority’s (the “FCA”) to drop its thematic review into “whether culture change programmes in retail and wholesale banks were driving the right behaviour” was met with utmost disdain.[i] In response to challenges by the UK Parliament, the FCA said they would continue to support and drive cultural change by supporting initiatives outside the FCA, including the work being carried out by the UK Banking Standards Board[ii] and the G-30.
The G-30 Report on banking conduct
The G-30 was established in 1978, as a private, non-profit, international body composed of senior representatives of the private and public sectors and academia. The aim of the G-30 is to deepen understanding of international economic and financial issues; to explore the international repercussions of decisions taken in the public and private sectors; and to examine the choices available to market practitioners and policymakers.
The G-30 Report on Banking Conduct and Culture: A Call for Sustained and Comprehensive Reform was published in 2015.[iii] The report focuses on promoting appropriate behaviour within banks in order to restore public trust; and ensure a safe and effective financial system. Primarily, the report highlights a number of cultural deficiencies, which were identified during more than seventy non-attributed interviews with: senior supervisors; board members; Chairs; Chief Executive Officers (CEO); and senior members of management in ‘many of the largest, and most complex global and domestic banks in sixteen countries’.
The interviewees were asked to provide their views on: (i) how individual firms embed desired values, ethics, and behaviours that collectively constitute culture; (ii) how they champion strict adherence to ethical values and discipline unethical behaviour; (iii) the challenges they face; and (iv) which approaches appear to work well and which do not.
Drawing from these opinions, the report makes a series of recommendations for an industry-led approach to improve culture in banks, transcending cultures and geographic borders. The report also provides roadmaps for banks and supervisors, which bring together the key recommendations and a set of key challenges, against which both banks and supervisors should measure their performance.
The overarching recommendation of the report is to encourage sustained embedding of improved culture and values by boards and senior management, with appropriate supervisory monitoring. In light of this, the report sets out a series of comprehensive reforms, which include:
- a shift in the overall mindset on culture – the report suggests banks approach culture, behaviour and conduct proactively, as an integral part of their business values and sustainable success strategy;
- senior accountability and governance – the report recommends CEOs and Executives ensure oversight of embedding values, conduct, and behaviours remains a sustained priority;
- improved performance management and incentives – this includes implementing compensation and promotion processes to ensure firms take account of desired behaviours, including consequences for weak management oversight or wilful blindness.
- staff development and promotion – where firms develop tailored programs for staff across all areas, which regularly reinforce what the desired values and conduct mean in practice. In addition, an emphasis should be made on diversity: cognitive; gender; racial; and background; as a key contributor to improved values and conduct and sustained behavioural change;
- an effective three lines of defence – the report recommends business line management, i.e. the first line of defence take primary responsibility for delivering the desired values and conduct. Compliance or Risk Management, i.e. the second line of defence, set the standards, monitor and provide advice to the first line; and the Audit function, i.e. the third line of defence, is robust, operationally independent, appropriately staffed and mandated to examine adherence to standards;
- whistle-blowing – where firms set out clear policies, escalation procedures and protection for internal whistle-blowing providing assurance to all employees that, if and when they report wrongdoing, their complaints will be taken seriously and confidentially and that they need not fear reprisals;
- employment history – this includes full due diligence on past employment history of potential new employees;
- regulators, supervisors, and enforcement authorities – the report suggests senior supervisors could add value by sharing best practice insights with executive management and the Board;
- industry-led standard-setting initiatives – the report welcomes industry bodies strengthening codes of conduct and creating transparency on implementation progress. This would complement, rather than duplicate, the work of conduct regulatory agencies.
Critique of the G-30 report on banking conduct
Whilst not detracting from the vast amount of work involved in completing the report[iv], there is something distinctively mysterious about the G-30 recommendations. The conclusions are supported by some academic references[v] however; the report appears to lack a quantitative evidential basis for its conclusions. For example, the report refers to interviews conducted with senior supervisors; board members; Chairs; CEO; and senior members of management in ‘many of the largest, and most complex global and domestic banks in sixteen countries’. However, due to anonymity concerns we are none the wiser with whom or which institutions these interviews were conducted. This non-attribution may be excused, however the responses provided are opinion-based or qualitative, which are not empirically supported by quantitative data.
In addition, the correlation between the opinion-based information and the report’s recommendations is opaque. This opaqueness together with the fact that the recommendations are built upon Board and Executive opinion may call into question their reliability and the industry’s willingness to implement those recommendations. In addition, there is an argument that the report should have included interviews with junior and middle management staff. For example, the UK Parliamentary Commission on Banking Standards explained in their report: Changing Banking for Good that there had been a “lack of personal responsibility [ ] throughout the industry [where] [s]enior figures have continued to shelter behind an accountability firewall”. In addition, “[m]any junior staff who may have done nothing wrong have been impugned by the actions of their seniors. This has to end.” By conducting interviews with junior and middle management the G-30 might have obtained an objective perspective on how senior management embed and champion adherence to ethical values, and discipline unethical behaviour.
Dutch Central Bank
In 2010 the Dutch Central Bank (the “DNB”) initiated, developed and implemented a new supervisory approach, which focuses explicitly on behaviour and culture risks. The approach is based upon independent scientific research, which relies upon a mixture of qualitative and quantitative research methods, including surveys, self-assessments, semi-structured interviews and Board observations.[vi] Applying this multi-faceted approach, the DNB carried out 54 assessments of banks, insurance companies, pension funds and trust offices, based on: board effectiveness; capacity for change; risk culture; search for yield; and root causes of supervision problems.[vii]
In their publication “Supervision of Behaviour and Culture: Foundations, practice & future development”, [viii] the DNB explain the importance of conducting research using a multi-method framework, referred to in scientific terms as triangulation. Whilst qualitative methods are often used to describe and explain organisational culture, the use of quantitative methods can help to reduce uncertainties, subjectivity and biases related to observations that are inherent in the use of qualitative approaches. Meanwhile, the recommendations of the G-30 report rely solely upon qualitative measures, which according to the DNB’s research may jeopardise an accurate interpretation of information.
The UK Banking Standards Board
Similarly, the UK Banking Standards Board’s pilot assessment, undertaken with 10 firms in 2015, relies upon a triangulated approach. The pilot exercise started with a set of four simple and yet searching questions from the Chairman of the BSB to the Chairmen of each bank or building society.
The Chairmen was asked to explain: (i) the purpose of their firm, the culture needed to deliver this and their priorities on culture, behaviour and competence over the next 12 months; (ii) the board’s priorities culture and competence over the past twelve months, the effectiveness of the steps taken to develop and embed the firm’s culture, and where the most and least progress has been made; (iii) whether management and staff at all levels across their firm live and exemplify the firm’s values, and how they know this; and (iv) the outcomes and behaviour the board seeks to incentivise for their firm’s staff. For each of these questions the Chairmen are asked to provide an evidential basis for their responses.
In addition, the BSB asked a number of questions of each CEO, aimed at extracting factual information on each firm’s processes and approaches relating to: (i) training and development; (ii) hiring, promotion and diversity, (iii) how the firm: measured staff engagement; communicated with employees; and sought to assess and manage culture, behaviour and competence. These themes were also tested with junior and middle-ranking staff through focus groups and 1:1 interviews. Meanwhile, investors, trade unions and consumer groups reviewed the assessment reports on an informal basis.
By contrasting the methodology of the G-30 report with the DNB supervisory approach to behaviour and culture and the BSB pilot assessments, we can derive some evidential shortcomings. However, the normativity of the G-30 report should not be underestimated. The gravitas, strength of leadership and global influence of the G-30 is irrefutable. Equally, the report’s recommendations are not entirely different from the conclusions reached by the DNB on cultural change.[ix] For example, the DNB also highlighted as areas for change: a shift in the overall mindset on culture; senior accountability and governance; improved performance management and incentives, employee development and diversity, an effective three lines of defence (risk, finance and audit), and the role of regulators, supervisors and enforcement authorities. Similarly, the key themes derived by the BSB from the 2015 assessment which merit reflection from the banks and building societies are: (i) the alignment of purpose, value and culture; (ii) the difference between a focus on culture, and on competence; (iii) leadership and key person risk; (iv) incentives and reward structures and practices; (v) fostering challenge and speaking up; and (vi) the provision, take-up and effectiveness of staff training and support.
The G-30 recommends that, given the long-term and sustained nature of the plight to improve culture in banks, there should be a review within 2 years of the major banks implementing their recommendations. In addition, the G-30 suggests that the review takes into account any additional reviews carried out by national bodies; and that the results of the review are published.
Ultimately, the effectiveness of the G-30 report will depend upon the extent to which the banking industry demonstrates its willingness to implement the report’s recommendations. It is hoped that this process will be supported through additional reviews carried out by national bodies, whose conclusions, which are founded upon empirical research, are broadly consistent with the G-30 report recommendations.
Institute for Regulation and Ethics, Centre for Commercial Law Studies, Queen Mary University
Conference to critically appraise the G-30 Report
On 4 May 2016 the Institute for Regulation and Ethics of the Centre for Commercial Legal Studies at Queen Mary University of London convened a one-day Conference to discuss and debate key recommendations in the report. The Conference was attended by G-30 members, senior members of the UK judiciary, regulators, philosophers, academics and practitioners, and considered the following questions:
- The importance of culture in banks;
- The role of law, regulation, supervision and enforcement in banking culture; and
- What banks can do to make meaningful cultural reforms.
For further details of the Conference and contact details, please visit: http://www.ccls.qmul.ac.uk/events/171079.html.
[i] See: https://www.fca.org.uk/static/documents/foi/foi4350-information-provided.pdf (Accessed 1 May 2016)
[ii] See the UK Banking Standard Board’s Annual Review 2015/2016, available at: http://www.bankingstandardsboard.org.uk/wp-content/uploads/2016/03/BSB-Annual-Review-20152016.pdf (Accessed 2 May 2016).
[iii] The G-30 report is available at: http://www.group30.org/images/PDF/BankingConductandCulture.pdf. (Accessed 1 March 2016).
[iv] The research for this report began in the autumn of 2014, led by a steering committee comprised of co-chairs Roger W. Ferguson, Jr. and William R. Rhodes; and vice chairs Gerd Häulser, John G. Heimann, and David Walker. They were supported by ten other working group members and observers. The report was project directed by Oliver Wyman, an interntional consulting firm.
[v] These are mostly drawn from organizational theory and social psychology disciplines.
[vi] See speech by Wijnand Nuijts, Head of Department, Expert Centre Governance, Behaviour and Culture, DNB, at “Looking forward: effective supervision of behaviour and culture at financial institutions”, Tropeninstituut, Amsterdam, the Netherlands, 24 September 2015, available at: http://www.dnb.nl/en/news/news-and-archive/speeches-2015/dnb326579.jsp. (Accessed 1 May 2016).
[vii] As a supplement to their long-term monitoring, the DNB performed additional assessments at nine institutions in order to gauge the effects of their earlier assessments, or because they received signals of risks emerging on one of the other topics. See: http://www.dnb.nl/en/binaries/DNB%20brochure%20gedrag%20en%20cultuur%202015%20ENG_tcm47-326577.pdf (Accessed 1 May 2016).
[viii] See Supervision of Behaviour and Culture, Foundations, practice & future developments, DeNederlandscheBank, Eurosysteem (27 November 2015), available at http://www.dnb.nl/binaries/Supervision%20of%20Behaviour%20and%20Culture_tcm46-334417.pdf. (Accessed 1 March 2016).
[ix] The BSB Annual Review 2015/2016 explains that the constrained nature of the 2015 assessment exercise and the non-random nature of the 10 firms that participated, means that the results of the pilot cannot be regarded as representative of the UK banking industry as a whole, or indeed of any individual firm. Furthermore, given the partial nature of the evidence base, the key themes reflect in some cases the BSB’s interest in investigating these issues further.