Tough rules can't re­pair bank­ing's cul­ture

The Pak Banker - - OPINION - Clive Crook

Suc­cess­ful economies need healthy banks. In 2008, the er­rors of the U.S. bank­ing sys­tem crashed the global econ­omy. Seven years later, the re­cov­ery in the U.S. and else­where is still tepid -and the fail­ure to get the fi­nan­cial sys­tem work­ing as it should is one rea­son why.

Fi­nan­cial rule-mak­ers haven't been idle, but that might be part of the prob­lem. In the U.S., it's ar­gued that the Dodd-Frank Act's fi­nan­cial re­forms have in­creased the reg­u­la­tory bur­den -- es­pe­cially on smaller banks -- so much that lenders can't sup­port new busi­nesses the way they should. There's prob­a­bly some­thing in this. Another crit­i­cism, also plau­si­ble, is that the post-crash fi­nan­cial re­forms have failed to mend the bank­ing in­dus­try's de­fec­tive cul­ture and hence re­pair its rep­u­ta­tion. Banks can't do what they're sup­posed to un­less they're trusted. Rep­u­ta­tional cap­i­tal mat­ters, both for the banks' long-run suc­cess as busi­nesses and for the wider econ­omy.

A study just pub­lished by the Group of Thirty looks in some de­tail at this ques­tion. (The G30 is a club of fi­nan­cial lu­mi­nar­ies in­clud­ing for­mer Fed­eral Re­serve Chair­man Paul Vol­cker; for­mer Euro­pean Cen­tral Bank Pres­i­dent Jean-Claude Trichet; Wil­liam Rhodes, for many years a top ex­ec­u­tive at Cit­i­group; and Roger Fer­gu­son, Pres­i­dent of TIAA-CREF and a for­mer Fed Vice Chair­man.) Dis­cus­sions about bank­ing cul­ture are hard to push be­yond plat­i­tudes about high stan­dards and in­tegrity, but the study is con- crete about where banks are fall­ing short and what man­agers and su­per­vi­sors need to do.

The prob­lem, ac­cord­ing to the study, isn't so much in stat­ing the goal. Most banks un­der- stand, or say they un­der­stand, the con­cept of rep­u­ta­tional cap­i­tal; most are try­ing, or say they are try­ing, to re­verse the col­lapse in trust in their in­dus­try that fol­lowed the crash. Yet banks of­ten treat these ef­forts as sep­a­rate from their main job -- an add-on, rather than a crit­i­cal task. The study con­trasts two ap­proaches to rais­ing stan­dards:

The first po­si­tions the chal­lenge as core to the eco­nomic vi­a­bil­ity of the in­sti­tu­tion, rather than a reg­u­la­tory is­sue. The sec­ond views the chal­lenge as de­fen­sive, with the aim of min­i­miz­ing fu­ture client re­dress, reg­u­la­tory fines and costs of com­pli­ance. This study finds that no more than a third [of banks re­viewed] are in the for­mer cat­e­gory. Fos­ter­ing trust de­mands a per­vad­ing cul­ture of do­ing the right thing even if the rules don't re­quire it. When se­ri­ous money is at stake, that's a tall or­der. Lead­ers there­fore have to live that prin­ci­ple, not just talk about it.

Ex­hor­ta­tion won't suf­fice, least of all from mid-level man­agers mark­ing time while the most tal­ented bankers are as­signed to more im­por­tant work. CEOs need to set up sys­tems to watch for be­hav­ior, es­pe­cially by se­nior ex­ec­u­tives, that might harm the bank's rep­u­ta­tion; when they see such be­hav­ior, they must pun­ish it -- and vis­i­bly. The re­port draws on re­search and in­ter­views and of­fers prac­ti­cal ad­vice for set­ting up such sys­tems.

What about out­side over­sight? The re­port stresses the dis­tinc­tion be­tween su­per­vi­sion and reg­u­la­tion. You need both, but they can of­ten be at odds. Re­ly­ing too much on rules rather than prin­ci­ples can cre­ate a nar­row com­pli­ance mind­set: If some­thing isn't ex­plic­itly for­bid­den, it's all right. The re­sult is per­verse. Find­ing ways to get around the rules be­comes praise­wor­thy. Cul­ture, says the re­port, is cru­cial -- but it can't be reg­u­lated, rule by rule. How­ever, it can be mon­i­tored and guided. The re­port it­self is a worked ex­am­ple.

Ask­ing how hard banks are try­ing to build trust and rep­u­ta­tional cap­i­tal, the re­port finds weak per­for­mance in many ar­eas. Boards of di­rec­tors aren't fo­cus­ing on the task. Man­age­ment deals too mildly with re­cur­ring cases of mis­con­duct. De­spite top-level lip-ser­vice about val­ues, mid­dle man­agers con­cen­trate on rev­enues, profit, and other stan­dard met­rics. Most banks talk about val­ues in their re­cruit­ment literature; few ask ques­tions about them in their re­cruit­ment in­ter­views. Tom Hayes, the UBS trader just con­victed in Lon­don of rig­ging bench­mark in­ter­est rates, made a lot of money for the bank un­til he was found out. Other banks tried to re­cruit him. The trial heard that the con­spir­acy was wide-rang­ing. The cul­ture, to put it mildly, was far too tol­er­ant for far too long. Su­per­vi­sors of­ten fail to no­tice these prob­lems un­til af­ter the dam­age is done. The fo­cus, ar­gues the re­port, is too much on pun­ish­ment af­ter the fact and not enough on preven­tion.

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