12 February 2019 Speech
Speaking to students of the Institute of Banking’s Professional Diploma in Leading Cultural Change and Ethical Behaviours in Financial Services
Good Evening Ladies and Gentlemen
I am delighted to be here this evening to address the first intake of students at the Institute of Banking’s new courses on leading cultural change and ethical behaviour in financial services.
You are studying a topic that could not be more timely as the question of how best to promote ethical behaviour and effective cultures is very much the focus of financial regulators both at home and abroad.
The Cost of Misconduct
That renewed focus is partly down to the persistence with which misconduct has occurred even after the financial crisis of 2008. It has been estimated that, in the decade since the crisis, global banks’ misconduct costs reached over $320 billion.1
In Ireland, too, we have seen serious misconduct in recent years prompting the Central Bank to require lenders to pay €647 million in redress and compensation to customers denied a tracker mortgage or put on the wrong rate – with often devastating consequences for those customers up to and including the loss of their homes and properties in some cases.
The result is a serious lack of trust in the financial services sector.2
The Slippery Slope
You can think of a culture as a system of shared values and norms that shape behaviours and mindsets within an institution – it is often defined as “the unwritten rules or the way things are done around here”.3
Some suggest that an ineffective culture could lead to increasing rates of bad behaviour through the “slippery slope’’ effect, where small demeanours lead to more significant deviant behaviour over time. So a workplace culture that tolerates minor misdemeanours may be setting itself up for far worse.
Behavioural economist Dan Ariely has described a “what the hell’’ effect –once you have gone down the wrong road, you might as well really enjoy the benefits of being unethical by engaging in even more immoral behaviour.4
Increasingly, the question being asked is whether unethical behaviour is driven by individual bad apples or the nature of the workplace itself – bad barrels if you will. While the role of bad apples cannot be ignored, there is increasing interest in the role of workplace culture in driving misconduct.5
Against that background, research suggests firms should focus on maintaining a “good barrel’’ – or an environment that influences individual choices for good.
This evening, I will explain what the Central Bank is doing to encourage firms to build good barrels by embedding a consumer-focused culture.
Safeguarding Stability, Protecting Consumers
But first, let me explain the Central Bank’s broader role.
We serve the public interest by safeguarding monetary and financial stability and by working to ensure that the financial system operates in the best interests of consumers and the economy.
In light of the wide range of financial conduct scandals both at home and abroad, in 2017 we established the Financial Conduct Pillar to emphasise the pivotal role that policing financial conduct plays in the delivery of our mandate.
We deliver consumer protection in many ways – through our work on financial stability, authorisation, prudential regulation, supervision, enforcement and redress.
But my focus this evening is on how we supervise firms with particular emphasis on the tools we are using to ensure that regulated firms are protecting consumers.
Our Supervisory Toolkit
Traditionally, we have used three main tools to supervise firms.
First, we engage in trigger-based supervision where we see issues arising from our own inspections of firms or intelligence we gather from whistleblowers or consumers, such as overcharging errors.
Second, we use thematic inspections to assess priority risks in particular industry or product areas. Last year, for example, we carried out a thematic inspection in relation to the sale of gadget insurance.
Third, we conduct detailed and intrusive examinations of priority consumer risks, such as the Tracker Mortgage Examination.
All of these tools give us valuable insights in to the firms we regulate and supervise, including whether they have a consumer focused culture.
For example, our most recent thematic inspection on gadget insurance found that 21 per cent of consumers do not cancel existing policies after taking out a new one. It is unlikely that such customers would willingly choose to pay “on the double’’ for their gadget insurance which raises the question of whether insurers are really putting their customers first.
We would certainly expect firms with a consumer focused culture to remind their customers to check whether they have any relevant existing insurance before recommending a new policy.
Consumer Protection Risk Assessment
Recognising the importance of influencing a more positive consumer focused culture in the firms we regulate, in 2016 we designed a new tool to add to our toolkit – the Consumer Protection Risk Assessment (CPRA).
When we carry out a targeted CPRA, we are assessing how firms are identifying and managing risks to consumers – in their strategies, business models, internal structures and processes.
We expect firms to be able to demonstrate, with clear examples, how their actions and communications are encouraging a culture of consumer protection throughout the firm. We want to see a culture of consumer protection in terms of how the firm is governed, how products are developed and sold, how post-sales issues are dealt with, how people in the firm are incentivized and behave and how they are ‘scored’ for their performance.
These things matter if we want to prevent the kind of misconduct that occurred at US Bank Wells Fargo where staff secretly opened millions of unauthorised bank accounts for customers in an effort to reach unrealistic sales targets.
Findings from CPRA Assessments
The CPRAs we have conducted recently paint a mixed picture of the culture at financial services firms. I will share with you this evening some of our findings – anonymized of course – to give you a sense of what we have found on the ground.
On the plus side, we found that accountability for consumer protection was evident in some role profiles and that firms had designed a number of frameworks and committees to help them meet their responsibilities with regard to consumer risk. We also found that variable remuneration was not guaranteed and took in to account qualitative measures aligned to consumer protection.
On the minus side, we found there was room for improvement in relation to performance management processes, particularly measurement and assessment of performance as it relates to consumer protection.
We also found that while firms have several formal and informal channels for employees to speak up about their concerns, in practice there were no actual examples of consumer issues being escalated through the formal whistleblowing process. Which begs the question – “why not?’’
In some cases, the role profile for the Chief Risk Officer or the terms of reference of the risk committee failed to reference accountability for risks to consumers, thereby resulting in insufficient evidence that consumer risks were discussed at board level. Again, I ask you – “why not?”
Wells Fargo – Bad Apples or Bad Barrels?
It is absolutely crucial that CEOs and boards give serious attention to the management of consumer risks.
In the case of Wells Fargo, which I mentioned earlier, it is clear that the CEO’s commitment to the sales culture led him to minimise problems with it. His reaction invariably was that it was simply a few bad apples causing issues. He was too slow and too late to call for inspection of, or critical challenge to, the basic business model, according to the 2017 report of Wells Fargo’s independent directors.6
The Wells Fargo board also failed to read the signals that appeared many years before it was made aware of the potential seriousness of the sales incentive issues. These included employee exit interviews and terminations, whistleblower reports, customer complaints, media reports and lawsuits.7
This highlights the importance for boards of obtaining timely and relevant information to help them ensure that the culture they have defined for their organisation is reflected on the ground.
Behaviour and Culture Report
During the course of the Tracker Mortgage Examination, the Central Bank detected a number of cultural indicators that were standing in the way of fair 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.
Amid public concern that the retail banks were dragging their heels on redressing and compensating customers, the Minister for Finance asked us to carry out a review of the culture at the main Irish retail banks.
The Behaviour and Culture Report we published last year provided a snapshot of the current behaviour of the executive leadership teams at AIB, Bank of Ireland, permanent tsb, Ulster Bank and KBC.8
The good news is that the report 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 report raised concerns around over-optimism regarding the successful transition to a consumer-focused culture. Many banks used the crisis as a baseline against which they measured progress. They felt confident that, if their bank could survive and emerge from the crisis, they were well placed to successfully complete the current organisational transformations.
In short, they were setting the bar too low and underestimating the scale of the challenge ahead.
The report also identified that two important pre-requisites for a successful cultural transformation were not met in all instances. In particular, there wasn’t always a collective understanding of what “consumer focus’’ actually means. In addition, the consumer focus was not always embedded in the banks’ structures, processes and systems.
As part of this exercise, the Central Bank also conducted Diversity and Inclusion assessments, which found that banks have much more work to do to ensure their organisations are sufficiently diverse and inclusive, particularly at senior level, to prevent group-think, guard against over-confidence, and promote internal challenge.
We have required the five banks to develop action plans to address the findings and mitigate the risks identified in our reviews. We are currently assessing the actions planned by the banks and will continue to engage on progress being made.
What Does Good Look Like?
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 with consumers at the heart of their decision-making. This means consumers can be confident that banks are acting in their best interests throughout their entire relationship with the bank.
We expect regulated firms to achieve a sustained improvement in culture by focusing on values and conduct that are the building blocks of culture. We expect firms’ ‘desired’ values and conduct to be reflected in the daily habits and practices of their employees. So, let me give you a few examples of what an effective culture would look like:
Values & Behaviours
- Firms have a set of values and expected behaviours in place that clearly articulate the intended culture of the firm.
- Values are designed so that employees feel accountable for their actions towards consumers.
- Expected behaviours are clearly articulated, easy to remember and act on, and written from an employee’s point of view.
- Firms are open to constructive internal feedback and have in place formal and informal channels to encourage and support employees to ‘speak up’.
Senior Accountability & Tone from the Top
- Each firm’s leadership team is highly visible in championing the firm’s desired values and conduct.
- Accountability for consumer protection at board/ committee level and at an individual level at all levels in the firm is formalised.
- Firms sanction employees for behaviour that is not aligned to consumer protection e.g. mis-selling.
Performance Management, Reward & Incentives
We want to see the expected behaviours reinforced at every stage of the employee lifecycle – recruitment, induction, training and development, promotion, for example:
- Promotion and remuneration policies and practices are designed to encourage employees to behave in a consumer-focused way.
- Employees are not assessed on short-term performance and financial metrics only.
- Disciplinary processes promote behaviour that is consistent with the firm’s values and expected behaviours.
Accountability is Key to Managing Conduct Risk
Internationally, it is recognised that culture must be continually managed and monitored at a senior level within firms.
In April 2018, the Financial Stability Board identified lack of accountability for misconduct as a key cultural driver of misconduct and recommended that national authorities identify and assign key responsibilities, hold individuals accountable and assess the suitability of individuals assigned key responsibilities.
Against that background, the Central Bank is 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 recommending to government that a Senior Executive Accountability Regime (SEAR) be implemented through legislation which would place obligations on firms and senior individuals to set out clearly where responsibility and decision-making lies for their business.
These requirements would assist in assigning responsibility to individuals in a regulatory context and decrease the ability of individuals to claim that the blame for wrongdoing lay elsewhere.
The primary purpose of the Central Bank’s reform proposals is to act as a driver for positive behaviours and recognition of responsibilities by individuals.
The Central Bank will, of course, continue to focus on ensuring that firms comply with the letter of the laws and regulations which firms must follow. But we also want to see boards and senior management setting the tone from the top by focusing on effective culture and values.
As the G30 has observed, this desired cultural shift will require leadership, persistence, and consistency to overcome years of entrenched behaviours and attitudes, and to ensure that the changes are lasting rather than ephemeral, or merely short-term window dressing.9
We know it can be done because we already have some very inspiring examples of how culture can be shifted and how regulation can improve lives. I am thinking of how our road safety and our smoking culture has changed for the better through a combination of legislation, regulation, industry action and social and behavioural change.
In that regard, I welcome the leadership shown by the Institute of Banking in offering these courses which give you, the current generation of bankers, the knowledge and tools to lead and embed effective cultures in your organisations and to earn the trust of your customers and the society in which you are licensed to operate.
2. Edelman Trust Barometer 2018
5. Ethical Culture: What, Why and How? Elizabeth Sheedy, Macquarie University, cited in Conduct Risk
A Practitioner’s Guide, Edited by Peter Haines