Why culture matters: Insights from the Central Bank of Ireland Review of Behaviour and Culture in the Irish Banking Sector - Director General Derville Rowland

Speaking at the European Banking Institute Global Annual Conference on Banking Regulation, Frankfurt.

Ladies and Gentlemen,

The last decade has uncovered a wide range of financial misconduct scandals around the world including LIBOR rigging, forex manipulation, tax evasion and money laundering, to name just a few. In Ireland, too, we had the Tracker Mortgage scandal which involved lenders denying customers a tracker mortgage or putting them on the wrong rate.

This overcharging had a detrimental and, in some cases, devastating impact on those customers, up to and including the loss of their homes and properties in some cases. It also further damaged the already fragile public trust in financial institutions - many of which had been bailed out at enormous public cost during the financial crash.

Against this background, in May 2017, the Central Bank restructured its Financial Regulation functions and established the Financial Conduct Pillar to emphasise the pivotal role that Financial Conduct plays in the delivery of its mandate.

The new Pillar’s mission is to regulate financial conduct with the aim of ensuring that the best interests of consumers and investors are protected and that markets operate in a fair, orderly and transparent manner. Our vision is for a trustworthy financial system supporting the wider economy where firms and individuals adhere to a culture of fairness and high standards.

The Tracker Mortgage issue also prompted us to consider whether we needed additional supervisory tools to help drive firms to combat a mindset that was clearly delivering poor outcomes for consumers.

We were conscious of the international debate about what makes people behave unethically and even unlawfully in the workplace. Was it individual bad apples or the nature of the workplace itself that was driving bad behaviour?

While the presence of bad apples cannot be ignored, there is increasing interest in the role of workplace culture – or the characteristics of the barrel in which the apples are stored.

You can think of culture as a system of shared values and norms that shape behaviours and mindsets within an institution – the unwritten rules or the way things are done around here.

A telling study into misconduct among US financial advisers found that about seven per cent of advisers on a national register had some form of misconduct on their record. Under the bad apple theory, you might expect to see these offenders randomly scattered through the industry.

But that was not the case. Some firms had higher or lower offending rates, suggesting that some were doing much better than others at creating an environment where misconduct is not tolerated and therefore happens less.

We were conscious too of global regulatory thinking. We noted the advice from the G30 that Boards should ensure that oversight of embedding values, conduct, and behaviours remains a sustained priority, with the primary responsibility resting with the CEO and Executive team for ensuring that the “tone from the top” has a clear and consistent “echo from the bottom.”

We weren’t alone in our focus on culture. As a result of widespread public disquiet about the banks’ conduct in relation to tracker mortgages, the Minister for Finance requested us to report on the existing cultures and behaviours in the retail banks, the risks associated with them, and the actions that could be taken to address them.

Last year, we published a report which proposed a series of reforms aimed at driving effective and sustained cultural change within the Irish financial services sector.

While the report focused on the five Irish retail banks, we believe its findings and recommendations have application across the financial services sector as a whole. I’ll return to the question of applicability in a moment.

But first let me tell you a little more about the background to the report. In the years after the crisis, as Irish banks continued to repair their balance sheets, a common theme began to emerge.

Banks were wrongly removing customers from, or denying them, tracker mortgage products to which they were contractually entitled. After pursuing tracker mortgage-related issues with a number of individual lenders, it became clear to us through extensive supervisory and enforcement work that similar issues existed across the industry.

As a result, we launched the Tracker Mortgage Examination, the largest, most complex and significant consumer protection review we have undertaken to date, probing all lenders who ever offered tracker products in Ireland.

The Examination is now in its final supervisory stages. To date, we have required lenders to return €647 million in redress and compensation to 39,800 customers. When they include their own administration costs, we expect the final cost to banks to top €1 billion – and that’s before the outcome of enforcement cases we are taking. We observed behaviour during the Examination that was repeated and widespread and indicative of a mindset that was clearly not delivering good outcomes for consumers.

We focused on the five Irish retail banks: Allied Irish Banks, Bank of Ireland, KBC, Permanent TSB and Ulster Bank. To undertake the assessment, we teamed up with our Dutch counterparts, De Nederlandsche Bank, leaders in the supervision of behaviour and culture.

We used our own Consumer Protection Risk Assessment methodology and elements of DNB’s Behaviour and Culture Framework. The review team included experts in conduct, prudential and governance risk and behavioural psychology. Over a two-month period, they undertook an estimated 1,400 hours of desk based review of a significant volume of information such as business strategies, organisational structures, role profiles and staff surveys.

They tracked a sample of two recent decisions at each bank which met two criteria. First, they involved balancing consumers’ interests with commercial interests. Secondly, they were complex involving several parts of the bank.

We used these decisions as a way to acquire greater insight into the processes governing strategic decision-making and actual behaviours. Our focus was primarily on the executive leadership team due to the importance of its members in driving effective cultures in which customer interests are adequately taken into account.

More specifically, we analysed:

• The leadership behaviour of the executive committee, including the drivers of this behaviour in terms of group dynamics and mindset; and
• The interplay between the executive committee and relevant internal stakeholders in the context of strategic decision-making.

As you will see, while our primary focus was on the executive leadership team, our review of each bank was wide and deep, involving extensive off-site and on-site analysis. The reviews produced detailed insights into behavioural and structural patterns in leadership, decision-making, communication, group dynamics and mindset that affect the way consumer needs are considered by each of the banks.

On the positive side, the reviews found that all five banks studied 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 the banks’ role in the crisis.

The reviews raised concerns with respect to leadership styles. In some banks, there is occasional reversal to ‘command and control’ styles cultivated during the crisis. The reviews also 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 feel confident that, given their bank managed to come through the crisis, they are well-placed successfully to 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 and to improve succession planning in the banks. Many senior managers continue to seek executive guidance and decisions on operational matters. This leads to congestion of executive decision agendas to the detriment of long-term, forward looking transformation efforts.

Finally, we also conducted Diversity and Inclusion assessments as part of the review. Again, we found that the banks have much more work to do in terms of ensuring their organisations are sufficiently diverse and inclusive, particularly at senior level, to prevent group-think, guard against over-confidence, and promote internal challenge.

We were acutely conscious that culture is a matter for each individual firm in the first instance. We will not prescribe a culture, there is no one size fits all and no two cultures will be precisely the same.

We believe that regulators can monitor, assess and influence culture within firms in order to guard against conduct risk and drive better outcomes for consumers and investors. In that respect, we expect firms to understand the risks faced by their consumers and investors and develop and embed comprehensive risk management frameworks to manage these risks effectively.

And this is our focus. In the first instance, we have requested the five banks to develop action plans to mitigate the risks identified in our reviews.

Building on our earlier work on culture, banks can also expect further changes in how we supervise them. We will conduct more intrusive, targeted conduct supervision of those firms that pose the greatest potential harm to consumers including robust challenge of board and executive management.

Over recent months, I have met with the boards of each of the banks to spell out in person what the Central Bank expects of them and their senior management teams and to form a judgment about their mindset and commitment to real change.
My message to board members – both executive and non-executive – has been this: responsibility for culture rests with the board and it’s on them when the culture in their organisation fails and results in consumer detriment.

Finally, given that we, like most regulators, are realists, we will also put an extra nudge into the system to keep firms on their best behaviour. A lack of accountability is widely seen as a key driver of misconduct and therefore we have proposed to government that they legislate for 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 proposing changes that will significantly reduce the chances of key people in firms being able to wash their hands of wrongdoing. We are proposing a Senior Executive Accountability Regime (SEAR) that would place obligations on firms and senior individuals to set out clearly where responsibility and decision-making lies for their business. We see this a key prong of our culture change strategy.

None of the above, in our view, should be seen as an imposition for industry, because I think the majority of firms we regulate would tell us these are precisely the standards and behaviour they already expect of their staff. The primary purpose of the Central Bank’s focus on culture is to act as a driver for positive behaviours.

But why all firms if our report focused solely on retail banks?

The short answer is we believe the risks identified are common across the financial industry, and that our response – in seeking to guard against misconduct – must therefore be industry-wide too. This is all the more important as, since the Brexit referendum, the Central Bank has seen an increase in the number of applications for authorisation from all sectors including investment banking and securities firms.

In order to build trust and confidence, we expect firms authorised in Ireland to meet the high conduct and prudential standards that are expected of any such firm authorised in the EU. We are not saying that our regulation of wholesale conduct and investor protection will precisely mirror our approach to consumer protection. There will be issues that are unique to each individual area. But I think it’s fair to say the end goals are the same: to reduce the risk of misconduct in firms offering financial services, whether it’s to retail consumers or sophisticated investors.

Already last year, for example, we carried out a thematic review of UCITS performance fees. These identified some non-compliance with Central Bank guidance and other poor practice. We have begun supervisory engagement with firms where instances of supervisory concern were identified. So there will be broad principles underpinning our approach to financial conduct as a whole.

And just as we engaged with the boards of the retail banks last year, later this year, I will be meeting the board of a lender primarily involved in wholesale banking – the starting point for a programme of engagement on the wholesale side.

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. Every member of an organisation should be clear on what is expected of them, and the consequences of deviating from such standards.

Firms should ensure the standards to which they aspire are understood and reflected in every business area, from corporate governance structures to individual accountability; from strategy setting to product development; from risk management to people management; and from internal challenge to how whistleblowers are treated.

There should be a dedicated focus at board and management level to ensure a truly diverse and inclusive organisation, from the top down, to mitigate risks such as group-think, over-confidence and lack of internal challenge, and to improve the quality of decision-making. It is essential to remember in all of this that people’s actions and words are merely the visible parts of culture – the chunk of the iceberg above sea level.

As the G30 notes in its latest publication on this issue, actions and words are directly influenced by what lies beneath the surface – a firm’s unspoken rules, ideas and norms.
In managing their culture, and minimising the risk of misconduct, firms across the financial services industry must therefore be alive to the whole of the iceberg – what’s visible, and what lies underneath.

Thank you.