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Rebuilding trust in financial services industry
TRUST in the financial industry remains low more than a decade after the global financial crisis. As the crisis showed, major financial institutions have grown so large and complex that they have become not only too big to fail, but also too big to manage, where senior leadership with oversight responsibility failed to monitor, detect and manage excessive risk-taking and misconduct within their organisations.
Global regulators have imposed over US$320 billion of financial penalties on banks. A slew of high-profile misconduct scandals has eroded consumer trust in the financial industry. These include the Lehman Brothers minibond crisis, Libor manipulation, foreign exchange rigging, money laundering, the opening of fraudulent accounts, and tax evasion, among many others.
Conduct risk is difficult to eliminate completely because human behaviour cannot be fully predicted or controlled. However, conduct and behaviour are closely correlated to an organisation's culture, where employees see what is valued and rewarded and act accordingly in order to be successful.
In view of increasing regulatory investigations, huge punitive fines on misconduct, growing cost of compliance and the resulting reputational damage, financial firms have a vested interest to go beyond a "tick the box" approach to compliance and develop more effective ways to manage and minimise conduct risk and promote good corporate culture. The tone from the top is not enough, particularly in large, complex organisations.
The tone from the top starts with the chief executive officer and senior leadership. Board and senior executive management are responsible for setting the tone and leading the direction of the firm. While tone from the top is important to champion messages of good culture across the organisation, it also needs to be authentic and consistent. Senior leaders must walk the talk in aligning business practices and decision-making with accountable and ethical behaviour. However, the tone from the top does not work if it's inconsistent with what actually happens at the middle management level and below.
Sub-culture and silos
Company culture communicated by senior leadership is expected to permeate through different levels of the organisation. However, large, complex organisations often have silos that exist across different business lines, departments, and teams with their own sub-culture, which can deviate from the overall direction of culture communicated by senior leadership, and have a greater influence on the actions of staff.
Cultural change must involve managers at all different levels of the company. The senior leadership may think it has successfully delivered its message. But if that message is not understood or accepted in the same way by middle management, that means it has failed to fully permeate down the organisation.
Middle managers are the immediate supervisors and role models for the majority of employees in day-to-day operations. Staff, particularly at the junior level, see what is valued and rewarded by their immediate supervisors and emulate similar actions in order to be successful. So, for good culture to percolate through the organisation, it must be exemplified from the middle as well as top management.
A number of regulators have implemented rules enhancing individual accountability at financial firms. These rules require firms to clearly identify key individuals and their ownership of responsibilities within business functions and other core units so that there is the transparency of individual accountability across core divisions. Regulators that have implemented individual accountability regimes include the UK, Australia and Hong Kong. Singapore will soon join their ranks.
Individual accountability rules have a profound influence on the way people behave. Since the names of key individuals are clearly identified, it instils in them greater awareness of regulatory obligations, as well as responsibility for any misconduct under their watch or failure to implement controls to prevent misconduct.
These rules make executives and senior managers more accountable, which in turn helps to strengthen the tone from the middle and the top. These rules have also created greater transparency in large global financial institutions with complex reporting lines.
Remuneration and incentives
Compensation is the most effective way to foster a good culture. Financial firms can implement effective systems to record staff behaviour and link it to performance reviews, promotions, and remuneration and incentives.
Some financial firms are using a balanced scorecard approach for staff who are responsible for revenue generation. This approach measures both financial and non-financial metrics in the assessment of staff performance and remuneration. Non-financial metrics may include customer satisfaction, complaints, and compliance with rules.
In 2016, the Monetary Authority of Singapore mandated financial advisers to implement a balanced scorecard approach in their remuneration framework for representatives who provide financial advisory services and their supervisors. The framework aims to strengthen professionalism, address conflicted remuneration, and improve customer outcomes.
Repairing a broken culture
Issues and views on culture were hardly heard of before the global financial crisis. But the numerous misconduct scandals around the world since then have made the connection between company culture, employee behaviour, and customer and investor outcomes all too clear.
Financial institutions must look deep within themselves to repair a broken corporate culture that wreaked havoc on public trust and the integrity of the financial system. The international Group of Thirty body has also weighed in and recently issued recommendations for financial institutions to improve culture.
Regulators are also increasing their focus on how regulations can improve culture across firms. They are exploring behavioural science tools to gain better insight into consumer and business biases with the aim of enhancing the supervision and regulation of the financial industry.
The implementation of financial regulation to increase the individual accountability of senior managers is only the beginning. Culture reform will continue to grow until trust is rebuilt again in the financial services industry.
- Sara Cheng is Senior Director of Capital Markets Policy and Strategy, Asia Pacific, at CFA Institute.