Learning to Lead: Cultural Change, Ethical Behaviour and Consumer Protection - Derville Rowland, Director General Financial Conduct

Address by Derville Rowland to the Institute of Banking

Good Morning Ladies and Gentleman, Mary (O’Dea, CEO Institute of Banking) and Clive (Kelly, President of Association of Compliance Officers Ireland).

I am delighted to be here today to launch the Institute of Banking’s new educational initiatives on leading cultural change and ethical behaviour in financial services and managing consumer protection risk. You are launching these programmes at a time when the role of culture is at the heart of important debates about governance in the public and private sectors.

This initiative chimes very much with the work that the Central Bank of Ireland has been doing on Behaviour and Culture at the Irish retail banks and the broader focus now being placed on culture at leading companies in Ireland. Just last month, the Institute of Directors published a report which revealed that while 59 per cent of boards have increased their focus on culture in the last five years, many are still failing to treat it with sufficient rigour to sustain the business into the future. Indeed, I have been struck by the consistency of many of the findings - namely that a lot of work is needed before we can say that cultural transformation has been achieved.

The people in this room today share an interest in education and will no doubt agree with the US philosopher, psychologist and educational reformer John Dewey who once said that “we do not learn from experience… we learn from reflecting on experience”.
It is in that spirit that I would like to consider with you today the implications of the Central Bank’s recent work on behaviour and culture at the Irish retail banks, its implications for financial institutions and for you as the educators of the next generation of bankers.

In the decade since the financial crisis, global banks’ misconduct costs have reached over $320 billion with the result that public trust in financial institutions remains very low.
This lack of trust is particularly evident in Ireland. Of 28 markets surveyed, Ireland is the least trusting of the financial services sector, according to the 2018 Edelman Trust Barometer. This is hardly surprising given that, in the years since the financial crisis, the retail banks have paid c€580 million in redress and compensation to customers denied a tracker mortgage or put on the wrong rate. Shareholders have paid a price too with the total costs to the banks amounting to almost €1bn when internal costs are included.
Given that misconduct can cause consumer detriment and, indeed, threaten the safety of financial institutions, regulators are increasingly focusing on how firms manage conduct risk, which has many drivers, including inappropriate, unethical or unlawful behaviour. There is also an increasing focus on culture, which drives behaviours and, ultimately, customer outcomes.

It is hard to define culture, but you can think of it as a system of shared values and norms that shape behaviours and mindsets within an institution – the unwritten rules or the way things are down around here. Culture is a matter for each individual bank in the first instance, and no two cultures will be precisely the same. However, organisations that have an effective culture share a commitment to high standards and values such as honesty, integrity and reliability. It is globally recognised that regulators cannot prescribe culture for individual firms. However, regulators monitor, assess and influence culture within firms in order to guard against conduct risk and drive better outcomes for customers.

The Central Bank expects regulated financial services providers to understand the risks faced by their customers and develop and embed comprehensive risk management frameworks to manage these risks effectively. Like other regulators worldwide, the Central Bank is increasingly insisting that firms comply not only with our regulations and codes, but also that the people who lead the firms we regulate and supervise set the right tone from the top and create a culture that minimises the risk of misconduct.

In business, of course, shareholder value and the bottom line are important. But it is also important that financial institutions operate within the regulatory framework and that their leaders build a culture that also serves their customers and the wider economy in which we license them to operate. Indeed, when Christine Lagarde, Managing Director of the International Monetary Fund, was in Dublin in June she spoke about how “those working in the financial sector must be as serious about values as they are about valuation, and just as passionate about culture as they are about capital.’’

The Behaviour and Culture Report the Central Bank of Ireland published during the summer provided a snapshot of the current behaviour of the executive leadership teams at AIB, Bank of Ireland, permanent tsb, Ulster Bank and KBC. The reviews were carried out at the request of the Minister for Finance amid public concern that the retail banks were dragging their heels on redressing and compensating customers who had been denied a tracker mortgage or put on the wrong rate.

During the course of the Central Bank’s Tracker Mortgage Examination, we detected a number of cultural indicators that were standing in the way of fair consumer outcomes. For example, we found banks adopting a narrowly legalistic approach rather than embracing a customer-focused perspective; assigning insufficient resources to the Examination; or offering initial compensation proposals that fell well short of our expectations.

When we carried out our reviews we decided to use a blend of our own Consumer Protection Risk Assessment Framework (CPRA) and tools developed by De Nederlandsche Bank (DNB), leaders in the field of behaviour and culture. The DNB framework focuses on group dynamics. The review team comprised conduct, prudential and governance risk experts and behavioural psychologists. The Central Bank’s framework focuses on issues such as leadership and tone from the top, speak-up and performance management, reward and incentives.

Our team held interviews with staff in each of the five retail banks - primarily members of the executive committee, but also members of the board. To give you a sense of the scale of the operation, we held interviews with 75 senior executives which amounted to 112 hours of interviews - each resulting in transcripts of up to 45 pages which the team then analysed. The key source of data on which the findings of the Behaviour and Culture reviews are based is therefore the perceptions of those senior interviewees themselves.

Over the past number of years, several developments in the banks’ external environment contributed to the prioritisation of their short-term financial interests at the expense of consideration of consumers’ interests. The good news is that the reviews found that all five retail banks have recently taken steps to reinforce the consideration of the consumer interest. However, the consumer-focused cultures at these banks remain under-developed and all five banks still have a considerable distance to travel.

The reviews revealed patterns in leadership, strategic decision-making and mindset that may jeopardise the successful transformation towards a consumer-focused culture. For example, several executive committees displayed ‘firefighting behaviour’, focusing on urgent and short-term issues. This may be a remnant of a crisis-era mindset, which persists due to the need to solve legacy and regulatory issues, often under intense media and political scrutiny - which is, of course, to be expected given banks’ role in the crisis.

The reviews raised concerns with respect to leadership styles. In some banks, remnants of the crisis-era mindset result in occasional reversal to ‘command and control’ leadership styles cultivated during the crisis. Different circumstances require different leadership styles, and an appropriate balance will always be required. However, banks undertaking comprehensive organisational transformations should place an emphasis on inclusive and collaborative leadership styles, aimed at integrating as many people and perspectives as possible.

Finally, the reviews produced concerns around over-optimism regarding the successful transition to a consumer-focused culture. Many banks used the crisis as a baseline against which they measure progress. They felt confident that, if their bank could survive and emerge from the crisis, they were well placed to successfully complete the current organisational transformations.

In short, they are setting the bar too low and underestimating the scale of the challenge ahead. We also found there was a need to empower senior staff to make decisions in order to decrease the decision making burden on the leadership teams. For example, many senior managers continue to seek executive guidance and decisions on many operational matters. This leads to congestion of executive decision agendas to the detriment of long-term transformation efforts.

The Central Bank also conducted Diversity and Inclusion assessments, which found that banks have much more work to do to ensure their organisations are sufficiently diverse and inclusive, particularly at senior level, to prevent group-think, guard against over-confidence, and promote internal challenge. The outcomes of this work are naturally confidential on an individual bank basis. But we have presented our observations to the executive boards and have sent the individual bank reports to the supervisory boards of each bank, while an anonymized report was sent to the Minister for Finance and published in July. My team and I have in recent weeks been addressing the boards of the banks in person to explain our findings and our expectations of the boards of directors.

We will engage in more intrusive, targeted conduct supervision

While culture is in the first instance a matter for the firms, regulators also have a role to play and we intend to play it.

Specifically, we will require the five banks to develop action plans to address the findings and mitigate the risks identified in our reviews. Supervisors will assess the actions planned by the banks and engage on progress being made. Building on our earlier work on culture, banks can also expect further changes in how we supervise them. We will engage in more intrusive, targeted conduct supervision of those firms that pose the greatest potential harm to consumers including robust challenge of board and executive management.

In the case of Wells Fargo’s Community Bank, there were signals that appeared many years before the board was made aware of the potential seriousness of the sales incentive issues which drove staff to open unauthorized accounts. These included employee exit interviews and terminations, whistleblower reports, customer complaints, media reports, blogs and lawsuits. It is really important therefore that banks obtain timely and relevant information that will help make sure that the culture they have defined for their organization is actually reflected on the ground.

Designing controls to manage consumer protection risk

I was particularly pleased to note that the Central Bank’s CPRA framework is a key component of both the educational initiatives the Institute of Banking is launching here today. The framework enables our supervisors to assess the design of a firm’s controls to manage and mitigate consumer protection risk and to determine how effective those controls are in practice.

In the wake of the Tracker Mortgage Examination, I would highlight the importance of ensuring robust product oversight and governance, when products are being designed, launched and also when they are withdrawn. Senior leaders must insist on obtaining the kind of information that gives them insights in to the customer experience on the ground – such as monitoring customer complaints to the bank and to the Financial Services and Pensions Ombudsman for example. The board must not be blind to issues that management chooses not to bring to its attention, rather the board must insist that the correct information is made available to it. An assessment of management information to monitor and track consumer outcomes is a key focus of our CPRA framework.

Rebuilding trust with customers

It is generally recognised that, in the aftermath of the financial crisis and more recent misconduct issues, most financial institutions need to rebuild trust with their customers, shareholders and the societies where they operate. But what they sometimes fail to see is that they must first become trustworthy. And that is where culture comes in. Culture is important from both a prudential and conduct perspective. Culture should be driven by institutional standards such as fairness, respect, integrity and honesty, which are promoted from the top down, echoed from the bottom up and visible throughout the organisation.

All regulated firms must implement conduct and consumer protection risk management frameworks that are proportionate to the nature, scale and complexity of the firm and the risks they are designed to manage. Firms should be asking themselves important questions such as: Is the tone from the top signaling the right values to staff? Are there clear lines of accountability within the firm? Are customers’ interests being taken into account when decisions are made in the boardroom? Are the right products being sold to the right people in the right way? Are staff incentivised to treat customers fairly? Have ambitious diversity and inclusion targets been set, especially for board and executive committee level? And is performance against those targets being measured?

Accountability is key to managing conduct risk

Internationally, it is recognised that culture must be continually managed and monitored at a senior level within firms. As recently as April 2018, the Financial Stability Board identified lack of accountability for misconduct as a key cultural driver of misconduct and recommended that national authorities identify and assign key responsibilities, hold individuals accountable and assess the suitability of individuals assigned key responsibilities.

Against that background, the Central Bank is recommending individual accountability measures to drive better behaviour. These include proposed Conduct Standards for all staff in regulated firms, such as acting honestly, ethically and with integrity; additional conduct standards for senior management; and standards for businesses. We are also recommending to government that a Senior Executive Accountability Regime (SEAR) be implemented through legislation which would place obligations on firms and senior individuals to set out clearly where responsibility and decision-making lies for their business. These requirements would assist in assigning responsibility to individuals in a regulatory context and decrease the ability of individuals to claim that the blame for wrongdoing lay elsewhere.

The primary purpose of the Central Bank’s reform proposals is to act as a driver for positive behaviours and recognition of responsibilities by individuals.

Conclusion: Culture contributes to long-term success

I fully support and welcome the focus by the Institute of Banking - and your partners at University College, Dublin and the Association of Compliance Officers in Ireland – on providing bankers with the knowledge and tools to lead and embed effective cultures in their organisations, to manage conduct risk and to develop a truly consumer focused culture.

I will leave you with the words of Maura Quinn, the CEO of Institute of Directors, on publication of the IoD’s report on Ireland’s Corporate Culture 2018. "Culture is the DNA of any organisation. Its values and practices are bequeathed to all future stakeholders. A strong and pervasive culture can ensure consistency within an organisation into the long-term, and contribute to long-term success.’’