FinReg outlook 2021 – Time to tackle culture

With culture the increasing focus of financial watchdogs, 2021 will be dominated by attempts to police what holds institutions together.

Regulators often stress the importance of culture to good decision-making at financial institutions. The importance of good culture seems obvious, but it begs a question: which culture? In this note, we briefly discuss “which” culture and consider what might be done to create what regulators call a “purposeful culture”.

A short history of regulatory pronouncements on culture in since 2000 might have the following chapter headings:

• “The way we do things around here”
• The measurement challenge or “Are we there yet?”
• Tone from the Top - Senior Manager Accountability
• “Not Just One Bad Apple”
• Risk Based Reward

We expect the next chapter to be headed: Purposeful Culture.

Recent legislative and regulatory reforms aimed at driving “good” culture have tended to adopt one of the following strategies:

• Emphasise senior manager accountability, with the threat of punishment for objective failure by a senior manager to take reasonable steps.
• Assume that "money is the root of all evil"² – or at least a root - and target the design of remuneration structures, and in particular by ensuring behaviours that drive misconduct and poor culture are not incentivised.
• Assume failure – misconduct and poor culture are inevitable, and whistle-blowers should be protected to ensure they can assist management and regulators to identify and address issues.

The “not just one bad apple” regulatory statements have refuted the self-comforting notion that a particular bank has an overwhelmingly good culture which might be sullied by just a few miscreants. But when it comes to the ultimate objective itself, regulators tend to state the desired outcome - "good culture" - without engaging with how best to achieve it.

Finance needs to ensure it stays true to its ultimate function of serving the economy, and people individually and collectively. In other words, stay true to its societal purpose.." - James Shipton, ASIC

Perhaps more challenging is the question of what “good culture” actually is – and can a bank (or any organisation) be said to have “a” culture, capable of being influenced. Indeed several regulators have noted the importance of looking for and dealing with potentially toxic sub-cultures: a variety of data is screened for signs that part of a bank might, for example, feel itself to be "special" in a way that leads to a disregard for or disrespect of the wider bank or its customers . Nonetheless, most regulatory discussions continue to speak of culture as something that can be shaped as a single set of shared values: “the way we do things around here”.³

In reality, we all self-identify with several cultural groups: perhaps national, ethnic, religious, political, social, generational or many others. That is to be encouraged and, it is commonly accepted, there are real benefits that arise from respecting diversity and ensuring inclusion.⁴ In this context, one of those cultural groupings will, of course, be as the employee of a particular organisation. But it seems that emphasising that particular identity, as bank employee, may actually increase the incidence of bad behaviour!⁵ In a series of experiments involving bank staff, the authors of a study published in 2014 observed a correlation between an increased incidence of cheating and the strong endorsement of statements on the materialistic values of the banking industry. They observed: "Our results suggest that banks should encourage honest behaviours by changing the norms associated with their workers’ professional identity." The ideas proffered as solutions included having bankers sign up to ethics statements and a focus on remuneration structures. 

Of course, there is a real risk (often observed) that signing a code of ethics, or certifying each year that relevant policies have been read and understood, become perfunctory exercises which do little to define appropriate norms and nothing to cause the signatory to identify with the right behaviours. The norms themselves may change and will need to be worked out over time.⁶ A more sustained effort is needed.

Looking forward, we expect to see regulators taking up the concept of “purposeful culture” currently championed by the UK Financial Conduct Authority (FCA). The revisiting of corporate purpose statements is highly fashionable⁷ and UK banks must now provide a public explanation of the wider stakeholder considerations behind principal decisions.⁸ Some early FCA discussions of “purposeful culture” seemed implicitly to stigmatize profitability but more recent statements seem to us more balanced, albeit highly challenging. For example: “We see a firm’s purpose as being a description of its economic function, and how it makes money. On one level, this is just a description of a firm’s business model. But we also go further, and say that in order to understand how a firm’s purpose drives its culture, you need to understand how a company describes, to itself and others, the essential purpose of the firm, its products and its services, and so its reason for existing, and why the world would be worse off without the value it provides.”⁹

The fallout from the Hayne Royal Commission has led Australian banks and regulators to focus on the importance of social responsibility and accountability and remedying the ‘trust’ deficit – recognising that the banking system relies on trust and confidence, which can only be established through a culture that promotes professionalism and care¹⁰. Similarly, the Australian Securities Exchange (ASX) Corporate Governance Council’s Corporate Governance Principles and Recommendations (effective from 1 January 2020) seek to address emerging issues around culture, values and trust – including a principle that listed entities should ‘instil a culture of acting lawfully, ethically and responsibly’ and a recommendation that listed entities should articulate and disclose their values.¹¹

The financial services sector has reached a tipping point in the journey to healthy, purposeful, safe, diverse and inclusive cultures that create healthy returns for shareholders. The question is how can we, together, tip the balance?"  - Jonathan Davison, FCA

Although many banks have published statements of purpose - and those have seen are worthy aspirations - they seldom seem adequate to the task of driving a purposeful culture. Most need reshaping if they are to drive behaviour. Those reshaped purpose statements will need to allow for diversity, and counteract the trap that some values traditionally associated with banking my actually encourage bad behaviour – perhaps by articulating attitudes and behaviours which are not acceptable.

How many employees know their bank’s statement of purpose, or think about it day-to-day? Regulators will demand much more than a revised aspirational statement that gathers dust. “Good” culture must be embedded through classroom training (albeit virtual – or perhaps socially distanced) to allow for the sharing of ideas that build on the diversity of experience, to drive a purposeful culture.

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