Changing banking culture

Sir Mervyn King wants "a real change in the culture of the [banking] industry. He's an optimist, I'll give him that.There are (at least) three big obstacles to such a change:

1. Bankers tend (with exceptions) to be selected for a money-chasing amorality. Most jobs in the sector are pretty dull - I'm surprised I stuck there for eight years - and "socially useless". The sort of people attracted to them are likely to be disproportionately motivated by hard cash.

2.The mere salience of money tends to make people more selfish (pdf) and more likely to cheat. It's  difficult to see how the salience of money in banking can be reduced.

3. Organizations and societies tend to display path dependence - they rarely change radically for the better quickly. To paraphrase Max Planck, culture advances one funeral at a time.

Now, I don't say this to deny the possibility that "strong leadership" might change banks' culture for the better - but it'll be a long haul.

But herein lies a problem. Talk of "culture" isn't just waffle.The trouble with banks is that they are riddled with principal-agency problems. Shareholders and regulators have only imperfect control over CEOs, CEOs have only imperfect oversight of senior managers, and senior managers have limited control over their underlings, and so on.

Now, many organizations have such problems. And in many of them, the solution lies in culture. For example, cultures of professional pride, reciprocal altruism or a work ethic ensure that workers do a good job even if they are not closely supervised. As - ahem - Bob Diamond said "the evidence of culture is how people behave when no-one is watching."

In banking, however, the culture that helps solve agency problems is lacking.

So, how to create it, given the obstacles I've described?

We could learn from pre-modern states. They imposed brutal punishments upon wrong-doers, in part because they needed to terrorize their subjects into submission simply because they had no other means of controlling them. Similarly, if shareholders or regulators cannot control bankers - and it looks like they can't, draconian punishments for wrongdoing are needed to keep them in line. As Voltaire nearly said, "it is wise to kill a banker from time to time to encourage the others."

Of course, such a policy has drawbacks. But the point is that radical change in the face of large barriers to change requires radical action.

Comments

[Luke]

A few weeks ago you were suggesting bringing back Captain Mannering to solve the banking crisis. Now it's crucifixion. Desperate times indeed. What do those (unlike me) who know about banking think of this proposal?

[Anon]

It is now in the public domain (I believe) that the practice of Libor fixing was widely known, was policy of the senior management of a particular bank, and was openly discussed in the media of the time. We have seen emails between traders, but where are the emails to and from Compliance on this subject? Did no-one raise this with the FSA or the BOE at the time? Has anyone looked?

The moral panic of the time demands we find Evil Traders and indulge in a collective orgy of contempt and fury at their behaviour. The truth appears to be more systemic, and encompass a wider range of people and institutions than currently figure in this story. But the last thing the government and the BOE want exposing is their own laxity and effective complicity in this, so I suspect we won't get the full story.

[Keith]

This post is not much use chris. It is not practical to apply severe punishments to bankers for legal and political reasons. But such punishments as are implied are immoral as punishments should nerver be barbaric or inhuman, even for barbaric crimes. Murdering children or buggering babies must still be regarded as more wicked then manipulating Libor. It is the worst kind of right wing chicanery to answer every social problem by demanding the return of the firing squad or hang mans noose.

Finance is merely the extreme example of the general capitalist culture of private greed. So the answer is Socialism as Einstein put it. Changing one element of a culture is very hard unless you change society as a whole. All the changes since at least 1979 have been in the "free market" Randian direction of Libertarian individualism. Morality is after all only for the ordinary people not the Gods of the new society of wealth. So no one should be shocked by the working out of this philosophy.

As this Randian ideology spreads further and is imported into every aspect of life in Britain expect more corruption. And more departures from human decency as a result.

[Ralph Musgrave]

Here are some “radical” ideas. First, stop private banks creating money out of thin air. Money is a NATIONAL asset which should be created by the NATION or nationalised agencies, like the central bank. Abraham Lincoln opposed the private creation of money, as did Milton Friedman, Irving Fisher and several other famous names.

Second, abolish an absurdity that is inherent in the current system. This is that money deposited in banks is 100% safe (thanks to the taxpayer), while that money is loaned on to borrowers who are not 100% reliable (especially in Ireland and Spain).

I.e. if depositors want their money invested by their bank in a commercial manner, such depositors can s**ding well carry the risk involved in that activity, that is lose their money when the bank goes bust.

I’m not saying that will solve all or even most banking problems, but if you want “radical”….

[Hoover]

It might be possible to introduce or increase personal liability for losses. When Bob Diamond renounces his bonus because of the public outcry, that's what we're de facto doing. So why not codify it?

Until 1855, directors were fully liable, and they somehow managed to fund the industrial revolution and the Napoleonic wars.

[Anonymous]

I agree with Chris.

The culture within banks must change. The change required is of a scale that draconian measures are necessary, although not sufficient. By draconian I mean summary dismissal and loss of livelihood for any bank employee acting against the public interest and / or unethically. This sanction should apply at every level, including directors and the CEO.

Once the consequences of acting improperly are understood by all and have been observed in action then more positive measures can be taken, including ethical training and better recruitment. Recruitment could be improved by introducing ethical criteria alongside the required technical competence.A culling of existing employees with the old mindset and culture may be necessary. But the first step in a culture change of this magnitude must be to instil the "fear of God" in employees stemming from a certainty that transgressions will lead to an instant P45, no ifs, no buts. Harsh, but necessary.

A remaining issue in this whole affair is the non-executive directives. Where were they? Their role is to oversee the executive directors (Bob Diamond et al). Clearly the corporate governance arrangements failed in this case.

The irony in all this is that the global financial community may have lost confidence in London as a trustworthy place to do business. London's decline as a financial centre may be a consequence. So the very laissez-faire, light touch regulation allowed to the City to promote its competitiveness may have back fired. A shame really.

[Metatone]

Culture is my business and while culture change is hard, I feel that far too often we're giving the CEOs in the banking sector the benefit of the doubt.

There are 2 or 3 good methods for monitoring and changing culture and 2 or 3 more that are less good, but popular in CEO circles. If Bob Diamond had been spending money/prestige on any of these methods (or indeed any method) to monitor and change the culture, I'd be a lot more sympathetic.

As it is, it's hard to have any sympathy when they weren't even trying. It's definitely true that the overall societal slide into Chicago School cod-economic-psychology has had an affect. But the reality is that in every major bank, the compliance/risk assessment/risk management function is a red-headed stepchild, usually treated as the enemy.

It's further the case that banks have reduced lending to ordinary people and businesses "to reassess their risk profile" whilst continuing to pour money into obscure and badly-understood financial instruments which cannot by any reasonable definition be understood to be less risky.

This suggests that there are a lot of things that you could do to affect the culture, which they are not doing - and not all of it is radical:

1) Create a culture of risk assessment. Add some rules about running things past risk assessment even when it's a routine thing. Get people in the habit of actually doing risk assessment. Exercise serious discipline for minor transgressions around risk assessment.

2) Invest more in the risk assessment personnel - so that there are enough to actually examine some things.

3) Invest in some culture monitoring. Change would have been a smaller job if it had been started earlier.

4) Bob Diamond making it to CEO was an ultimate symbol of a broken culture that valued money made over methods. There's been all sorts of questions about methods on his watch - Barclays took the view that "if it wasn't illegal, then why should it tar Bob's reputation." The answer is that if you wait for the law to catch up with the bad practice, your culture will have gotten way out of hand.

5) Proper culture change methods to go along with the monitoring may have invoked some radical changes. So I'll keep them separated out, but they may have involved spinning off divisions that are too different, creation of extra rules for the sake of the culture, changing oversight mechanisms (which could cost a lot of money.)

To reiterate the main point again, there are many things Bob could have been doing - and he wasn't doing any of them. So he doesn't deserve any "culture change is hard" sympathy.

[Sean]

Ritual public humiliation? An appearance on the Jeremy Kyle should do it.

[Account Deleted]

The culture of banking is a product of the structure of banking, so calling for a change to this culture (like all calls for moral improvement) is to confuse cause and effect.

Draconian punishment only works if the risk of being caught is high and the proceeds of the crime are relatively small. While the value of financial transactions (and thus the quantum of commission) continues to grow, and while regulation biases towards the light-touch, then the risk/reward trade-off will remain attractive.

If you have a 90% chance of making a million in a year, and a 10% chance of being executed, there are plenty who will consider it a risk worth taking.

[Keith]

It strikes me that this can be considered an example of how offering large financial rewards is a crude method of motivating people. It suffers from the same draw backs as threatening savage punishments. Both offering large rewards and threatening punishments can produce undesirable and unwanted effects. Giving uncreative and unimaginative people huge wads of cash does not make them any more capable of the sort of work that does produce more wealth for society as a whole.

Talking about morality in this context is pointless really. What is needed is an effective method of promoting economic efficiency which clearly is lacking as the accepted methods are too simplistic based on a pavlovian carrot and stick analogy. Developing real human talent and creativity is a subtle issue not sorted out by these incentive structures.

[Opinion Prole]

Don't banks have internal auditors? Or are they all in on the scams too?

[Anonymous]

@Fromarsetoelbow

Yes, you are right.

The risk/reward ratio must be considered and adjusted. Properly designed internal controls should greatly amplify the risk of getting caught.

The existence or not of internal controls reflects an organisation's culture. A dearth of controls may be found either in high-trust organisations or in "wild-west" organisations where anything goes (eg the banks it seems).

So yes, when the potential rewards are very high people chasing those rewards will take on risk. So effective internal controls must be such that they greatly increase the risk of getting caught. Secondly, those who are caught must suffer a harsh consequence - instant dismissal, I suggest, (but in accordance with natural justice).

I don't believe any of this is rocket science and a board of directors worth its salt should have installed such controls. The fact that the Banks do not seem to have such systems in place says a lot about their culture.

Culture is set from the top. It is not just Bob Diamond at fault here. The non executive directors, whose role is to supervise / oversee the work and performance of the execs, are also at fault. They too should walk the plank, although this is a decision for the shareholders.

Of course, shareholders want high financial returns. They profit from an unethical culture where this increases distributable profits. So measures also need to be taken to penalise them when their returns have been so obtained. Penalties on them must be such as to alter their calculus. This will hopefully activate them to ensure they appoint an ethical board of non-executive directors.

[Stephane Genilloud]

Chris, you have some taste for addressing the real issues.
Some reasonable economists like Brad DeLong or Simon Wren-Lewis are starting to question what's wrong with economics. It looks like what went really wrong is that economics neglected such crucial issues, focusing instead on some market imperfections that look marginal in comparison. Banking is certainly more important to the economic system than enhanced competition or a flexible labor market.
Ignoring the role of banking in the economy (a macro problem) or the incentive towards risk created by disproportionate bonuses for bankers (a micro problem) was a far worst mistake from economists than assuming that agents behave rationally.

[Luke]

I think people are missing Chris's (slightly tongue in cheek) point. Losing your job is not enough. Every one faces rhat risk. Improving risk assessment is not enough. Would bankers' behaviour change if the consequences of failure was crucifixion and your children being sold into slavery? He's not advocating that (nor am I), just wondering what it would take to change bankers' behaviour.

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