Banking and Misconduct: A Critique of the Cure of Culture

28 03 2018

Strangely enough, after controversially abandoning a long-awaited revolutionary review of culture in banking, the FCA has started to invoke the mantra of culture yet again. In that regard, Transforming culture in financial services DP18/2 advocates a pressing need for financial firms to clean up their act because cultural complications have been “a key root cause of the major conduct failings that have occurred within the industry in recent history.” Being prescriptive about the panacea of culture is quite an odd thing for the FCA to indulge in yet again. Worse still, the idea that a wider culture is to blame makes a mockery of individual culpability and provokes irresponsibility. The approach is misconceived and fundamentally flawed. Jonathan Davidson, the FCA’s director of supervision, predicts at the outset of the discussion paper that organisational and societal change cannot be brought about by a “quick fix” because of “the complexity of human dynamics.” Events demonstrate that the FCA is in denial about the reality of things. Blaming bad culture has failed as a defence for many people such as Tom Hayes, Jonathan Mathew, Jay Merchant and Alex Pabon who were prosecuted and jailed for benchmark rigging. The FCA’s latest theory is that culture is manageable despite being immeasurable. On any view, this is a fallacious argument because the calculus of culture is not only measurable but has already been clearly recorded as conduct costs, £264 billion between 2012-2016, by the CCP Research Foundation. The systematic arrangement and coding of these costs shows that bad culture and culpability can be readily measured.

Generally, one can only agree with the practical effect of many a cultural mission statement, when everyday conduct, ethics and accountability are what will truly drive good outcomes for customers and engender trust. No issue is taken here on the good work many of the banks are doing in this space. The conduct costs research was never intended to be a means by which to bluntly expose a bank’s conduct costs. Rather, it was to identify a proxy indicator of culture. CCP Research Foundation readily accepts the limitations of this metric. It would further accept that there are many initiatives, controls and/or mitigants that, if properly implemented, would act to promote good behaviour and outcomes for customers; as opposed to shining a light on misconduct post facto. The indirect effect of the capture (and publication) of a firm’s (and/or its peer’s) conduct costs on behaviour is clearly subordinate to such a priori measures. Aside from the lack of guidance and substantive discussion on how to effectively measure and manage common grey area conduct risk, the fact that the regulator is highlighting the culture issue again must, on its face, be applauded. Importantly, any criticisms voiced in this post are my personal views alone.

Notably, a year ago Andrew Bailey sought to argue that Culture in financial institutions: it’s everywhere and nowhere. In a speech criticising controversial industry practices, the FCA’s boss addressed a mixture of themes such as executive pay, governance and accountability. He concluded that “culture change in itself is a challenge, and we know it takes time.” If anything, this is a fitting description of the FCA’s own weak culture. The FCA loves to concentrate on its regulatory achievements. For example, in setting out the case for the City watchdog’s Accomplishments of the last 5 years the FCA’s chairman John Griffith-Jones made it a point to speak incessantly about the great difficulties of being a regulator. The FCA lacks the will to critically evaluate itself and this failing is self-evident from the one-sided nature of its renewed initiative to transform culture in financial services. No trace of critical self-reflection can be found in DP18/2. A few years ago, prior to dumping the review of culture in banking with the Treasury’s approval, employing similar terminology the FCA was at pains to point out that ignoring culture creates the consequence of losing out on “an opportunity to tackle one of the major root causes of conduct failures.”

It is not in doubt that regulators where caught out sleeping at the onset of the global financial crisis (GFC). Martin Wheatley’s “shoot first” aggression made a poor example of things, especially given his own propensity to undermine confidence in the markets by way of negligence as demonstrated by the damage he caused to insurance companies because of giving a reckless press conference. Before the arrival of Wheatley, positioned at the other extreme of the spectrum, Hector Sants seems to have embraced a pacifist approach to regulation. For example, in his Report into the FSA’s enforcement actions following the failure of HBOS Andrew Green QC found it surprising that Sants was clueless about the FSA’s failures, in particular that there was “inadequate communication between him and enforcement.”

Other officials such as John Tiner (FSA Chief Executive, 2003-2007) are said to have designed an “insufficient approach to supervision”; Sir Callum McCarthy (Chairman FSA, 2003-2008) insufficiently oversaw FCA executives and “was too trusting of firms’ management and insufficiently challenging”. Margret Cole, who headed enforcement from 2005-2012, is said to have engaged in “highly unsatisfactory” decision-making and indulged in a “misguided approach”. She is accused of having a lax attitude to things. The Review into the failure of HBOS Group found that Cole’s soft touch to supervision was “insufficient” because she veered off the regulatory track towards the view that only strongly actionable cases – or those with extremely high prospects of success – merited investigation and enforcement action.

In their roles as “sleeping policemen”, individuals such as Sants, Tiner, McCarthy and Cole appear to be highly culpable in manifesting unmitigated negligence rather than doing their legal duty to the public. The dominant culture of shirking responsibility in regulatory circles is recorded in an enforcement manager’s remarks to Green that “enforcement against big bankers had become virtually impossible.”

These days, Bailey is under fire and faces “serious questions” because of the FCA’s failure to publish its investigation into the Royal Bank of Scotland’s “disgraceful” mistreatment of small businesses. The FCA’s handling of the situation has been dubbed nothing short of “desperate”. Equally, the fact that the FCA’s incoming chairman Charles Randell admitted that he invested in a tax avoidance scheme does little to boost public confidence in the regulator. The FCA has also been criticised for never using, in 11 years, European rules on money laundering. Since it prefers to exercise its civil powers, Johnathan Fisher QC has said: “The FCA is tasked with keeping markets clean and one way to do that is to is to bring the odd deterrent prosecution.”

Culture, we are misinformed, is a difficult concept to measure. Overall, “it is manageable” but the FCA discourages a “one size fits all” approach and it elects to be non-prescriptive about what any firm’s culture should be. Essentially, four things stand out, namely a firm’s purpose, leadership, its approach to rewarding and managing people, and governance arrangements. Transforming culture in financial services DP18/2 stretches to over a hundred pages and consists of a collection of 28 essays purporting “to provide a basis for stimulating further debate on transforming culture in the sector.” Anyone who reads these essays will be struck by the loose way in which the authors treat hard issues of ethics and misconduct. The upshot is that one cannot help but feel that these supposedly weighty personalities are living in a fantasy. Like Alice, they are in Wonderland. Like Marie-Antoinette, they also appear to indulge in a Qu’ils mangent de la brioche or Let them eat cake mentality.

The cult of the FCA’s essayists examine four themes connected to (i) pinpointing a “right” culture, (ii) the role of regulation, (iii) the role of reward, capabilities, and environment in driving behaviours, and (vi) leading cultural change. But what lies after the introductory pages of DP18/2 leaves the reader even more bewildered. Odd analogies are drawn with historic improvements observable in drink driving cases. Terms such as “bad apples” and “rotten eggs” are utilsed and one preliminary conclusion is that “culture change is complex and difficult.” Similarly, the five conduct rules of the Senior Managers and Certification Regime (SMCR) are elevated to scripture. Leaders, it is said, are able to “manage” culture despite not being able to “measure” it.

The degree of denial of responsibility is so extreme that in his essay entitled Creating a culture of ownership the president and chief executive of UBS AG London Branch, Andrea Orcel, calls culture a “common way of thinking”. Yet like the FCA he completely fails acknowledge, or even mention, the terrible practices that UBS manifested and the bad culture of LIBOR rigging that underpinned its operations. Tom Hayes, who worked at UBS prior to moving to Citibank, accused the Swiss bank of encouraging wrongdoing and distributing instructions on benchmark rigging. Whatever Tom did he has been punished for it. But his bosses remain untouched.

Take for example the essay submitted by the, chief executive officer, Banking Standards Board (BSB). In searching for the “right” culture Alison Cottrell advances the argument that “good culture is about more than ensuring good people don’t do bad things – it’s about enabling good people to do better things.” In my view, it is very important to ensure that bad people should be stopped from doing bad things, something left unaddressed in her essay despite her most noble intentions. She makes some fleeting points about hierarchical nature of responsibility but, save safeguarding customer rights, nothing of substance can be found in her brief comments on culture. The present situation is no different from a few years ago when the BSB quite rightly issued a general warning that the “banking industry must raise its game” because “trust in the system has been badly damaged and it’s no surprise that the public expects change after everything that has happened”. On the other hand, diminishing the plausibility of their own theory, they also offered a general concession to the industry:

Banks recognise the urgent need to raise their game and build the necessary momentum for change. It won’t happen overnight and it will be an uncomfortable journey but the time has come to win back trust.

Trust has not been won back and despite substantial revisions to the rulebook corporate scandals show few signs of abatement. From what I can see, BSB does not want the banks to be burdened with any serious misconduct issues hanging in the balance. This has been their historic stance as they are afraid that conduct rankings might encourage a blame game and finger pointing against the banks and the bigwigs that run them. It is clear that this is an ambivalent way to look at things. In the essay entitled The Denial of Reality: An exploration of some of the unconscious forces at work in Financial Services, Ajit Menon discusses the predicament of culture in the banking world. He rightly attacks the role of UBS management but his analysis falters because he excessively dwells on the story of Oedipus Rex without acknowledging that the tale is in reality particularly close to the historic failings of the FCA.

The word “conduct” appears 194 times in the paper but apart from a handful of instances (four to be precise) the expression arises specifically in relation to the words “Financial Conduct Authority” inscribed on the header of every page. Of course, the FCA controversially spent £66,400 on redesigning its logo by engaging Saatchi and Saatchi. The obvious problem with such a profligate culture is that the “new” logo is exactly the same as the old one; they are both virtually identical.

Numerous other flaws exist in DP18. For example, right at the outset the summary/overview makes gross generalisations about creating a good culture and states that visual imagery – such as a picture of Dr Martin Luther King – “can activate a higher moral identity and influence decisions.” This is akin to saying that putting up a picture of Mahatma Gandhi will make people peace activists or putting up a picture of Churchill will make people resilient. If Dr Martin Luther King’s portrait is hung in a bank where there is widespread corruption, then such an act will clearly defile his picture and mix him up with the wrong kind of folks.

Lots of ink is spilt over the quest for recruiting the “right” people. Thus far, the “right” people, or the chosen ones, have shown themselves to be colossal thieves and liars. Very little doubt exits on this point. Again, however, the summary/overview can be read to mean that change will be slow to come and that top management personnel are not really to blame and should be treated favourably. This of course directly contradicts the ethos behind the SMCR. Indeed, rather tellingly, the FCA even descends into making this rather perverse analogy:

Like losing weight, culture change is not an 8-week crash diet or a single project but a whole lifestyle change – an ongoing business priority.

The FCA’s analysis of culture could benefit hugely by incorporating an analysis such as the one articulated in Seven Deadly Sins: ‘Retrospectivity, Culpability and Responsibility’. The formula of these culpability codes consists of: Case 1: Clustered Criminality, Case 2: Corporate Regulatory Breach, Case 3: Imputed Breach, Case 4: Corporate Regulatory Failure, Case 5: Individual Criminality, Case 6: Corporate Reputational Event and Case 7: Individual Reputational Event. These culpability codes operate on a simple assumption: no business is perfect and not all misconduct is equally evil. But of course some forms of misconduct are unpardonable. In my view, these codes can be used as a tool to assess cultural problems and identify areas where room for improvement exists.

In tandem with the £264 billion in conduct costs incurred by the world’s 20 leading banks during the five-year period 2012-2016, the structured methodology advocated by the CCP Research Foundation set out above serves as a ready tool to evaluate, and perhaps even predict, cultural change in banking and financial services. Using such a method allows us to see culture in black and white terms rather than the shades of grey concocted by the authors and promoters of Transforming culture in financial services DP18/2. Overall the discussion paper totally devoid of any real ideas and is hugely misleading.

The £264 billion figure represents an increase of 32 per cent on the period 2008-12. Accordingly, a worrying aspect of adverse bank behaviour is reflected in the uninhibited expansion of conduct cost provisioning. As Chris Stears has explained, the key question relates to the average level at which these costs will settle. Similarly, five years after publishing the first league table for international bank fines, Roger McCormick remains unimpressed by cultural change:

We find ourselves wondering when, if ever, the level of conduct costs will start to decrease.

Overall, it is hard not to conclude that the FCA’s discussion of transforming culture is a failure from the very outset because it does not in any way shape or form represent reality. It is equally unpalatable that the FCA and the banks it regulates refuse to accept any responsibility for their own woeful failings. Clearly, an accountability gap exists the financial services sector and rich regulators and elitist banks tend to rule the roost even after the purported “clean up” of the marketplace in recent years. Even to a politically neutral person who does not trust any extreme view point and believes in secularism and democracy, the idea that regulators can use Brexit as an excuse to shy away from the historic problems dogging the sphere of financial services is completely unacceptable. 



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