Strengthening Financial Services Conduct

BY JOHN MONGELARD

The culture within the financial services industry has been under scrutiny since the 2008 global financial crisis. The successes of the financial services industry in enhancing the lives of the world’s population and furthering economic and business development were quickly forgotten in the wake of this crisis.

Essentially, what went wrong – excessive lending, profit maximisation at the expense of unwitting customers, fixing benchmarks for personal gain and taking advantage of small businesses – occurred when financial services made decisions that moved away from
providing necessary, responsible social infrastructure and lost its proximity to customers and clients.

Since then, an enormous amount of work in markets around the world – both mandatory and voluntary – has been done with the collective aim of fixing various aspects that were found to be deficient or that enabled the crisis to occur in the first place. While regulation and policy changes can help improve processes, ultimately conduct, incentives and the way leaders judge and understand performance are key components to bring about cultural change within the industry.

CONDUCT
Organisational culture is an important driver of behaviour, and cultural values can help people and businesses do their best by encouraging conscious and mindful good behaviour. In creating or even strengthening culture within the financial services industry, it is important to focus on good conduct and promote customer-centric thinking as an everyday
consideration. Employees and management alike should be encouraged and supported to be passionate about the business’ products or services in the way which real customers use them. This makes it easier for them to understand and appreciate how the outcome of their business decisions, actions and activities affect people. It also provides direction and
helps to build a sense of belonging and relationship with the customer.

Even when a culture provides clear support and direction, human behaviour is unpredictable and imperfect. Accepting imperfection and understanding why bad behaviour has previously occurred can help organisations address aspects of their culture that may enable misconduct. The ‘Fraud Triangle’ is a useful model to consider when trying to frame this understanding and implement effective approaches to counter bad behaviour.

A good, strong culture is fundamental to combat undesirable pressure and influence. After misdeeds occur, it is not surprising to hear rationalisations such as ‘everyone else is doing it’, or ‘I’m helping to meet targets’. This thinking can allow ordinarily moral individuals to justify poor behaviour and this must be dealt with through meaningful consequences.

Positive, desirable values should also be built into the recruitment process so that at every opportunity, all employees are encouraged to use their quick thinking and initiative for good.

Consistency is also vital to cement good behaviour. Humans instinctively consider the behaviour of others, especially their leaders who determine their rewards and career progression. The importance of ‘tone at the top’ is well accepted but the challenge lies in consistent demonstration. However, if good conduct is everyone’s culture, it will be an ordinary part of business that can be constantly executed.

INCENTIVES AND PROFITS
A focus on good conduct and cultural change must be supported by how businesses operate.

Two key practical issues that can reinforce or undermine this change are certainly incentives and the use of financial targets. Despite very high performance-related pay for
many in the industry, the following soft factors have been found to have equal if not greater influence:
• Peer recognition
• Senior recognition
• Promotion, and
• Doing ‘what makes life easy’

While regulation is important, having more regulation can be counter-productive. The more
rules there are, the more people stop using their own judgement, effectively turning off the ‘ethical chip’ in their brains. This can lead to a ‘moral drift’ where the lesser of two evils makes it the right decision even though it is not. This thinking leads to moral distress,
where even in cases when people know it is the right thing to do, institutional constraints make it nearly impossible for them to pursue the right, ethical course.

Despite clear financial incentives for ethical behaviour at the corporate level in financial services firms, there is still evidence that these institutions remain strongly focused on short-term return-onequity (ROE) metrics. When there are such economic consequences, it can be challenging for people to change the way of doing business.

Financial services organisations must therefore understand and be clear about where profits are generated. With this understanding, targets for individuals, teams and departments can then be set more consciously with conduct considerations at the
forefront.

Having a cohesive framework for setting ROE targets also enables the organisation to properly align risk and reward, and clearly communicate the rationale to shareholders.
For example, financial institutions could look at:
• Rewarding good behaviour, not simply financial performance
• Dealing effectively, clearly and consistently with any employee that does not behave well, even if they meet targets
• Deferring large pay outs for achieving financial targets

PURPOSE
Resilient businesses are built on trust and driven by purpose. While culture comes from within, purpose imparts an outside perspective and provides a link to the customer and the real outcomes of a person’s actions. Financial service organisations must therefore
be underpinned by purpose to meet the economic needs of society, and this should be prioritised above short-term profits and bonuses.

Remaining connected to purpose provides the necessary grounding and direction for people to work in an ethical way, regardless of timing, circumstance or other pressures. It also gives people the context and resilience to make difficult decisions, and is necessary
to cement good culture and conduct. Without purpose, financial service organisations will struggle to differentiate themselves or gain the trust of customers.

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John Mongelard leads the Institute of Chartered Accountants England and Wales (ICAEW) programme on financial services issues that have a risk or regulation theme. He has worked in various supervision roles and looked at the large UK banks, international
banks and insurance companies and has undertaken risk assessment work on bank capital, business models, risk management frameworks and corporate governance.

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