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Corporate Culture and Individual Responsibility in Banking

2018 marks 10 years since the most serious banking crisis in generations and one that imposed enormous economic and social costs on a wide range of stakeholders.

Along with various forms of misconduct, trust and confidence in banking has been eroded; indeed there is market research evidence that the reputation and esteem of banks has been badly affected.

In the words of an authoritative Group of Thirty report: “The reputation of banking and the broader financial sector has deteriorated since the financial crisis and is now at an historical low in terms of trust on the part of clients and customers”.

There is also criticism that those responsible for the crisis and examples of bank misconduct seem not to have been adequately punished, if sanctioned at all. While this is not altogether true, we can understand why the perception has arisen.

Types of Misconduct

Four types of bank misconduct can be identified: cavalier risk management; mis-selling of financial products to potentially vulnerable consumers; violations of national and international rules on, for instance, money laundering; and manipulation of financial markets.

In other words, the crisis of 2008 (whose effects are still working through) is not the only factor. Other much-publicised examples of misconduct in the UK include mis-selling of PPI and pensions, instances of rogue trading, the manipulation of LIBOR and money laundering. As a result, massive fines have been imposed on banks – but who exactly pays the fine, or should be sanctioned, is a central issue.

This is important because trust and confidence is crucial in financial services for several reasons:

  • some financial products are only purchased once, which means there is limited opportunity to learn from experience;
  • there is a principal-agent relationship between financial firms and their customers;
  • the value of many financial contracts are not known at the point of purchase and so it is not always clear precisely what we are buying;
  • given the long-term nature of many financial contracts, the behaviour of the financial firm after the transaction has been made impacts on the ultimate value of the contract;
  • and there is often a lack of transparency in complex financial contracts.

Furthermore, many financial transactions (e.g., investments and pensions) are longterm in nature where trust places a vital role. The erosion of trust is, therefore, a serious issue.

Identity Economics

In the School of Business and Economics we have postgraduate and undergraduate modules devoted entirely to examining the specific factors that contributed to the financial crisis. But ultimately it is the underlying culture of the banks and the degree to which individuals within the banks are held accountable.

Culture is central in all firms when considering corporate responsibility. Different authors have offered a wide variety of definitions of “culture”. For our purposes we refer to that given by Allison Cotterall (Chief Executive of the Banking Standards Board): “Collective assumptions, values, beliefs and expectations that shape how people behave in a group”.

The group focus is important because we learn from Identity Economics (and our own experience) that people behave differently in different environments. We all of us have multiple identities: in the family, amongst friends, in our job, etc. Behaviour is often different in each area.

We can assume that those bankers who attempted to illegally rig market interest rates (the LIBOR scandal) would not steal from their local corner shop or sell an inappropriate financial product to their beloved grandmother. People behave differently in a group than they do when acting alone. Group culture is therefore a central issue to consider.

The culture of any firm or organisation is important to understanding individual and collective behaviour: it creates business standards, influences employees attitudes and generally establishes norms of behaviour. This in turn provides a link with consumer trust and confidence. This is particularly important in banking and finance because of the pivotal role that financial firms and banks, in particular, play in the economy.

Is Regulation the Only Answer?

The financial crisis has spawned the biggest change ever in banking’s regulatory regime. But is this the right approach? My experience having been involved with the regulation of banks is that regulation is a necessary but not sufficient condition for good behaviour.

There needs to be a greater focus on the underlying culture of banks because if this is hazardous no amount of regulation will prevent misconduct.

“Who should be held responsible for bad behaviour? The firm itself or its decision makers?”

At the heart of many instances of misconduct is a combination of hazardous culture, perverse incentive structures within financial firms, weak internal governance arrangements and a lack of individual responsible and accountability. No amount of regulation can compensate for bad ethical behaviour.

When considering the banking crisis and various examples of hazardous behaviour, two issues immediately come to mind: who was responsible and why? When focussing on the who it is a question of whether the focus is to be on the institution or the individuals working within it. Banks do not make decisions; it is the individual employees that make decisions.

But culture and individual behaviour interact in a complex way: individual behaviour can influence corporate culture, and established culture influences individual behaviour.

Effective Change

It is also a question of effectiveness: What is likely to influence future behaviour more – a £10 million fine on the bank (ultimately the shareholders and customers themselves) or a £50,000 fine on individual employees?

Personally, I believe it needs to be both in order to truly change the culture, with a regime that makes individuals responsible and accountable for their actions.

“The erosion of trust is a serious issue.”

Reform is needed, and the previously mentioned Group of Thirty report has argued that: “A major improvement in the culture of banks is now a matter of necessity and sustainability and is an imperative for regaining society’s trust”.

Supervisors should examine the underlying culture of financial firms, and individuals need to be made more accountable for their actions and decisions when there is a negative impact on consumers’ welfare.

A welcome move comes with the Financial Conduct Authority’s Senior Managers Regime which has recently come into force. Regulators now require that all relevant employees within financial firms are covered by: “a set of conduct rules and act with integrity, due skill, care and diligence… and pay due regard to the interests of customers and to treat them fairly...”

In addition, senior management is specifically targeted, with individual employees to be held responsible for their actions with the possibility that they may be sanctioned.

Culture has changed within banks as anyone in the UK who watches Dad’s Army will know. The local bank manager in the programme may have been a pompous fool, but everyone had trust and confidence in him, and he always acted with the utmost integrity.

While he managed a much simpler bank than exists today, perhaps there is a case for: “Come back, Captain Mainwaring – all is forgiven”.

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About the author: David T Llewellyn

David T Llewellyn is Professor Emeritus of Money and Banking and a member of the Economics discipline group. David can be reached on d.t.llewellyn@lboro.ac.uk

David Llewellyn